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ECON 2100 Study Guide - Midterm Guide: Sustainable Development, Precautionary Principle, Polluter Pays Principle

Course Code
ECON 2100
Doug Auld
Study Guide

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ECON 2100 Midterm Review
Powerpoint Slides
Slide One
In every economic transaction, there is an exchange of property rights between the buyer and
Common property (land, fish, air) complicates this, as it is difficult to assign property rights to
things that do not belong to anyone in particular.
Restricting common property rights is one solution to the improper use of key resources such as
air and water.
Assigning private property rights to a resource is another way to ensure a more efficient use of
natural resources resources.
The fundamental reason the market does not work for environmental goods is due to the
inability to assign private property rights to much of the natural environment.
Slide Two
An externality is a cost that is not accounted for in economic activity but is nevertheless a real
cost. It occurs because of the absence of property rights.
The REAL cost of any economic activity is a combination of PRIVATE COSTS PLUS EXTERNALITIES.
Slide Three Residuals
Residuals are the excess from production of goods that have no value. They are typically
dumped back into the environment after production.
Residuals aren’t necessarily pollutants, but a pollutant is a residual of economic activity.
Types of Residuals
Non-Accumulative: Noise, excessive light
Accumulative: Waste, plastics, lead
Partially Accumulative
Sources of Residuals
Point Source: Something where you can see where it is coming from. Ex SO2
from a coal generating station.
Non-Point Source: Where something may have many sources and one main one
cannot be identified.
Residuals enter the environment -> Environment is transformed biologically or physically -> “New”
environment imposes costs on society.

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Examples of Pollution resulting in real value damages:
Mercury dumped into rivers > Kills off fish > Loss of tourism or commercial fishing.
Slide 5 Sustainability
Sustainable development is meeting the needs of the present generation without compromising
the future generations.
Common property resources, like fish, are undervalued and overconsumed.
If the rate of depletion from commercial activity and natural causes is greater than the increase
in stock due to reproduction, the stock of fish will decline and eventually disappear.
Trees are not mobile and can be assigned private property rights.
There is a difference between present value and future value. If an owner of acres of land with
trees wants to sell these acres to a buyer, why would the government intervene?
They would do so because such resources as forests create positive externalities. (Carbon sink,
water supply management, wildlife habitat)
Slide 6(?) Catastrophe Modeling
Catastrophe modeling: Looking at an event with a low chance of occurring but a large cost if it
does occur.
The possible outcome is otherwise known as the expected value of the event. It can be shown in
the equation EV = (sigma) * Q where sigma is the probability and Q is the monetary cost.
Example: If a probability of a gas pipeline breaking is 0.01, and a spill would cost $500 mil, then
it would be EV = 0.01 * 500,000,000 = 5,000,000.
Usually such probabilities would increase over time, so in the example it could make sense that
over a longer and longer time period, the pipeline would age and become weaker, so this
probability could grow from 0.01 in the first 10 yrs, then 0.05 in the next 10 and 0.10 in the last
EV = [0.01 * 500]+[0.05*500]+[0.10*500] = 80 Million.
There are two ways that the government can step in to help avoid catastrophes.
1) Regulation: Gov’t can hire experts to set financial standards for the operation of the
activity. The economic costs are those incurred by the activity to meet regulations
and those borne by the public.
2) Insurance: Firms MUST carry catastrophe insurance. Insurance premiums are tied to
the expected outcome. Ex. Fire insurance on two identical houses will differ
depending on distance from fire station.
Firms can reduce insurance premiums by spending on things that can reduce the probability of disaster.
(Refer to lecture 7 Graph)

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Precautionary Principle: If an activity could result in a catastrophic event, what would be the
consequences of NOT allowing the activity to proceed?
Lecture 8: Supply and Demand
Since it is common to write y=f(x) on a graph, we can write an explicit demand equation.
P=7-1.0 Qd.
We can transpose this to Qd = 7-p
The explicit supply curve might be p = 0.5Qs
Or, if Qs depends on MC… Qs = p/0.5.
p/0.5 = 7-p
Qs = 4.67 = Qd
A conventional approach to addressing economic activity that pollutes is to impose a tax
on each unit of output produced by the polluter. (See graph on lecture 8)
Taxing each unit of output will discourage high amounts of pollution and may have firms
producing at a lower quantity due to not wanting to pay the tax.
For example, on the graph, a tax will lower environmental damages by the whole taxed
area, h+d+g. A net improvement in social welfare of efficiency.
Lecture 9: Socially Efficient Level of Pollution
Key thing: Reducing pollution draws resources out of production and consumption elsewhere in
the economy. That is, there is production that is foregone because we are trying to cut down on
There is an environmental DAMAGE FUNCTION: It is the relation between quantity of waste
being emitted and the economic value of the damage caused.
(See graphs on lecture 9) We should relate marginal economic damage not only to the output of
the firm, but the emissions themselves that are coming from the firm.
Marginal Environmental Damage [MED] curve is modeled by MED = f(E)
The damages from pollution rise incrementally and the waste level increases incrementally.
In an industry with many firms, TOTAL MED function is the sum of the MED for each firm.
If a firm discharged waste, it has two options to reduce the level of damage. It could:
1) Reduce the volume of waste
2) Modify the waste by treating it before it’s discharged.
Both of these options are going to come at a cost to the firm. For example, trying to recycle the waste or
treat it. They would become more expensive the more pollution abatement that one is trying to achieve.
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