Lecture 1 — fundamentals
Environmental economics is the study of allocating and managing scarce natural and
environmental resources optimally, while accounting for externalities.
• Allocating: choices have to be made about production and consumption (resources are
scarce).
• Managing: policy and governance are needed to enforce or stimulate choices.
• Scarcity: if something becomes relatively scarce, its relative value rises.
• Optimally: we keep changing behaviour/policy as long as marginal values di er
(because marginal analysis tells us when to stop).
• Externalities: costs/bene ts from a decision that fall on people not involved in the
transaction.
Economic approach & core concepts
Two distinctions in the economic approach:
1. Positive economics (positivistic): Describes what is / what was / sometimes what will be.
• Example: “What are the costs of reducing emissions?”
• Example: “How much does demand decrease if price increases?”
2. Normative economics: Deals with what ought to be from a broad welfare perspective.
• Example: “How much pollution should be allowed?”
• Example: “Are market outcomes desirable?”
Environmental economics uses both approaches: positive economics to understand
consequences, and normative economics to decide what policies are socially desirable.
Marginal utility
Economists use the concept of utility to describe how much bene t, value, or satisfaction a
person gets from consuming a good or service. Utility is not measured in real physical units like
kilograms or euros; it is a way of describing how strongly someone prefers one option over
another.
Marginal Utility and Consumer Choice
Utility represents the satisfaction derived from consuming a good or service. Marginal utility (MU)
is the additional satisfaction gained from consuming one extra unit. Marginal utility typically
diminishes as consumption increases, which explains downward-sloping demand curves.
Total utility (TU) is the sum of marginal utilities across all consumed units. Total utility increases as
long as marginal utility is positive and reaches its maximum when marginal utility equals zero.
The absolute units of utility are irrelevant; what matters are ratios of marginal utilities, which
re ect preferences. Consumers allocate their budget to maximize total utility by purchasing goods
with the highest marginal utility per euro (MU/P). Consumers continue reallocating spending until
MU/P is equalized across goods.
Marginal utility and marginal bene t are conceptually equivalent; marginal bene t expresses
marginal utility in monetary terms via willingness to pay.
Marginal utility (MU) is the extra satisfaction you get from consuming one additional unit of a
good or service. For example, the rst chocolate bar might give you a lot of satisfaction, but the
second might give you less additional satisfaction, and the third even less. This “extra satisfaction
from the next unit” is marginal utility.
A key idea is that marginal utility can be positive, zero, or negative:
• If marginal utility is positive, you still gain satisfaction from consuming more.
• If marginal utility is zero, consuming an extra unit adds no extra satisfaction.
• If marginal utility is negative, consuming more makes you worse o (for example, you feel
sick after too much chocolate).
1
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, Diminishing Marginal Utility
Marginal utility usually declines as consumption increases. This is called diminishing marginal
utility. It means that the rst unit of a good is often the most enjoyable, and each additional unit
adds less enjoyment than the one before.
This is important because it helps explain why demand curves slope downward in economics. If
people get less extra satisfaction from extra units, then they are only willing to buy more units if
the price falls.
Total Utility vs. Marginal Utility
Total utility (TU) is the total satisfaction from all units consumed. Total utility rises as long as
marginal utility is positive, because each extra unit adds something. Total utility reaches its
maximum when marginal utility becomes zero. If marginal utility becomes negative, total utility can
start to fall because extra consumption reduces overall satisfaction.
This is why in many graphs:
• The marginal utility curve slopes downward.
• The total utility curve rises at rst, then attens, and can eventually decline once marginal
utility turns negative.
Why the Unit of Utility Does Not Matter (Ratios Matter)
The exact numerical value of marginal utility is not what matters most. What matters is the
relative size of marginal utilities, because they re ect preferences. For example, if you say a
chocolate bar gives 100 “utility units,” that number is arbitrary. The important thing is how it
compares to something else. For example, if one fruit gives you 20% more satisfaction than a
chocolate bar, then if chocolate has MU = 100, fruit would have MU = 120. The numbers could
also be MU = 10 and MU = 12 and the logic would be the same. The key point is that utility
numbers are meaningful mainly in comparison.
How Consumers Allocate Money: Marginal Utility Per Euro
When someone has a limited budget, the economic idea is that they should spend money in the
way that gives the most satisfaction per euro. This is why economists use marginal utility per
price, written as:
MU / P
This tells you how much satisfaction you get from each
euro spent.
Example (from your notes, explained)
Suppose:
• A chocolate bar costs €1.
• Fruit costs €2 per kilogram (so you can buy
fractions, like half a kilogram).
• The rst chocolate bar gives MU = 100.
• The second chocolate bar gives MU = 80.
• Fruit gives MU = 120 for 1 kg, so MU/P = 120/2 =
60 per euro.
Now compare:
• 1st chocolate: MU/P = 100/1 = 100
• 2nd chocolate: MU/P = 80/1 = 80
• Fruit: MU/P = 120/2 = 60
If you have €5, you maximize total satisfaction by always buying the next item with the highest
MU per euro remaining. So you would buy chocolate rst (highest MU/P), then chocolate again,
and only once chocolate’s MU/P falls to about the same level as fruit’s MU/P would you start
buying fruit.
This consumer rule is important because it connects utility to market behavior: people keep
buying more of something until the extra satisfaction per euro is no longer better than the
alternatives.
2
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, Relation Between Marginal Utility and Marginal Bene t
In environmental economics (and microeconomics), marginal bene t (MB) is usually measured in
money terms, especially as willingness to pay. Marginal utility (MU) is measured in satisfaction
units. They are closely related: marginal bene t is basically the monetary expression of marginal
utility, because willingness to pay re ects how valuable the next unit feels to you.
That is why your notes say MU and MB are “basically the same,” except MU is usually in abstract
satisfaction units and MB is usually in euros.
Bene ts, Costs, and Marginal Concepts
Economists evaluate decisions using a cost–bene t framework.
• Total bene ts are the sum of all bene ts from an activity.
• Total costs are the sum of all costs from an activity.
However, decisions are made at the margin:
• Marginal bene t (MB) is the additional bene t of one extra unit of an activity. It is often
measured as the maximum willingness to pay (WTP) for that extra unit.
• Marginal cost (MC) is the additional cost of producing one extra unit, including
nancial and opportunity costs (what must be given up).
Environmental economics relies heavily on marginal analysis, because optimal outcomes occur
where marginal bene ts equal marginal costs.
Marginal Analysis
Many environmental questions are: how much production/pollution is optimal and when should
we stop?
The rule is:
• If marginal bene t is greater than marginal cost (MB > MC), producing more increases total
welfare.
• If marginal cost is greater than marginal bene t (MC > MB), producing less increases total
welfare.
• The optimal level of activity is where MB = MC, because this maximizes net social
bene ts (total bene ts minus total costs).
This rule applies to production, consumption, pollution, and resource use.
adam smith – invisible hand
Adam Smith argued that when individuals pursue their own self-interest, markets can lead to
socially optimal outcomes through price signals. This is known as the invisible hand.
In a perfectly competitive market without externalities:
• Prices re ect true costs and bene ts.
• Marginal bene t equals marginal cost.
• Consumer surplus plus producer surplus is maximized.
• Private costs and bene ts equal social costs and bene ts.
However, environmental problems almost always violate these assumptions, mainly because of
externalities.
Demand, Supply, and Market Equilibrium
• The demand curve represents marginal bene ts. Each point shows how much
consumers are willing to pay for one more unit.
• The area under the demand curve equals total bene ts, or total willingness to pay (WTP)
• The supply curve represents marginal costs. Each point shows the cost of producing
one more unit.
• The area under the supply curve equals total production costs.
Market Equilibrium
• Market equilibrium occurs where quantity demanded equals quantity supplied.
• This intersection determines the market price (Pm) and market quantity (Qm).
3
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, • If there are no externalities, this equilibrium is economically e cient because it
maximizes total welfare.
demand shifts when preferences, incomes or substitute prices change
supply shifts when production costs, technology or number of rms change
Economic e ciency
An allocation of resources that maximizes net social bene ts.
Perfect competition without externalities is e cient.
Surplus and welfare
• Consumer surplus (CS) = WTP − Price → example:
WTP €5, price €3 → CS = €2
• Producer surplus (PS) = Price − Cost → example:
price €3, cost €0.50 → PS = €2.50
Total welfare (net social value) in the market: Welfare = CS +
PS
demand & supply (cake example)
willing to pay 5 euro for cake (WTP), cake is 3 euro ⇾
consumer surplus = 2 euro. baker’s costs = 0.50 ⇾ producer
surplus = 2.50 euro
Elasticity (important for tax incidence)
Elasticity measures how responsive quantity is to price
changes.
• Price elasticity of demand measures how much
quantity demanded changes when price changes.
◦ A atter demand curve means demand is more
elastic.
◦ A steeper demand curve means demand is more
inelastic.
• Price elasticity of supply measures how much quantity supplied changes when price
changes.
Elasticity matters because it determines who bears the burden of taxes and how markets
respond to policy.
Why Supply Curves Slope Upward
Supply curves slope upward because of increasing marginal costs:
• In the short run, rms face the law of diminishing returns.
4
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Environmental economics is the study of allocating and managing scarce natural and
environmental resources optimally, while accounting for externalities.
• Allocating: choices have to be made about production and consumption (resources are
scarce).
• Managing: policy and governance are needed to enforce or stimulate choices.
• Scarcity: if something becomes relatively scarce, its relative value rises.
• Optimally: we keep changing behaviour/policy as long as marginal values di er
(because marginal analysis tells us when to stop).
• Externalities: costs/bene ts from a decision that fall on people not involved in the
transaction.
Economic approach & core concepts
Two distinctions in the economic approach:
1. Positive economics (positivistic): Describes what is / what was / sometimes what will be.
• Example: “What are the costs of reducing emissions?”
• Example: “How much does demand decrease if price increases?”
2. Normative economics: Deals with what ought to be from a broad welfare perspective.
• Example: “How much pollution should be allowed?”
• Example: “Are market outcomes desirable?”
Environmental economics uses both approaches: positive economics to understand
consequences, and normative economics to decide what policies are socially desirable.
Marginal utility
Economists use the concept of utility to describe how much bene t, value, or satisfaction a
person gets from consuming a good or service. Utility is not measured in real physical units like
kilograms or euros; it is a way of describing how strongly someone prefers one option over
another.
Marginal Utility and Consumer Choice
Utility represents the satisfaction derived from consuming a good or service. Marginal utility (MU)
is the additional satisfaction gained from consuming one extra unit. Marginal utility typically
diminishes as consumption increases, which explains downward-sloping demand curves.
Total utility (TU) is the sum of marginal utilities across all consumed units. Total utility increases as
long as marginal utility is positive and reaches its maximum when marginal utility equals zero.
The absolute units of utility are irrelevant; what matters are ratios of marginal utilities, which
re ect preferences. Consumers allocate their budget to maximize total utility by purchasing goods
with the highest marginal utility per euro (MU/P). Consumers continue reallocating spending until
MU/P is equalized across goods.
Marginal utility and marginal bene t are conceptually equivalent; marginal bene t expresses
marginal utility in monetary terms via willingness to pay.
Marginal utility (MU) is the extra satisfaction you get from consuming one additional unit of a
good or service. For example, the rst chocolate bar might give you a lot of satisfaction, but the
second might give you less additional satisfaction, and the third even less. This “extra satisfaction
from the next unit” is marginal utility.
A key idea is that marginal utility can be positive, zero, or negative:
• If marginal utility is positive, you still gain satisfaction from consuming more.
• If marginal utility is zero, consuming an extra unit adds no extra satisfaction.
• If marginal utility is negative, consuming more makes you worse o (for example, you feel
sick after too much chocolate).
1
fl fi fifi ff
fi fffi
, Diminishing Marginal Utility
Marginal utility usually declines as consumption increases. This is called diminishing marginal
utility. It means that the rst unit of a good is often the most enjoyable, and each additional unit
adds less enjoyment than the one before.
This is important because it helps explain why demand curves slope downward in economics. If
people get less extra satisfaction from extra units, then they are only willing to buy more units if
the price falls.
Total Utility vs. Marginal Utility
Total utility (TU) is the total satisfaction from all units consumed. Total utility rises as long as
marginal utility is positive, because each extra unit adds something. Total utility reaches its
maximum when marginal utility becomes zero. If marginal utility becomes negative, total utility can
start to fall because extra consumption reduces overall satisfaction.
This is why in many graphs:
• The marginal utility curve slopes downward.
• The total utility curve rises at rst, then attens, and can eventually decline once marginal
utility turns negative.
Why the Unit of Utility Does Not Matter (Ratios Matter)
The exact numerical value of marginal utility is not what matters most. What matters is the
relative size of marginal utilities, because they re ect preferences. For example, if you say a
chocolate bar gives 100 “utility units,” that number is arbitrary. The important thing is how it
compares to something else. For example, if one fruit gives you 20% more satisfaction than a
chocolate bar, then if chocolate has MU = 100, fruit would have MU = 120. The numbers could
also be MU = 10 and MU = 12 and the logic would be the same. The key point is that utility
numbers are meaningful mainly in comparison.
How Consumers Allocate Money: Marginal Utility Per Euro
When someone has a limited budget, the economic idea is that they should spend money in the
way that gives the most satisfaction per euro. This is why economists use marginal utility per
price, written as:
MU / P
This tells you how much satisfaction you get from each
euro spent.
Example (from your notes, explained)
Suppose:
• A chocolate bar costs €1.
• Fruit costs €2 per kilogram (so you can buy
fractions, like half a kilogram).
• The rst chocolate bar gives MU = 100.
• The second chocolate bar gives MU = 80.
• Fruit gives MU = 120 for 1 kg, so MU/P = 120/2 =
60 per euro.
Now compare:
• 1st chocolate: MU/P = 100/1 = 100
• 2nd chocolate: MU/P = 80/1 = 80
• Fruit: MU/P = 120/2 = 60
If you have €5, you maximize total satisfaction by always buying the next item with the highest
MU per euro remaining. So you would buy chocolate rst (highest MU/P), then chocolate again,
and only once chocolate’s MU/P falls to about the same level as fruit’s MU/P would you start
buying fruit.
This consumer rule is important because it connects utility to market behavior: people keep
buying more of something until the extra satisfaction per euro is no longer better than the
alternatives.
2
fi fi fi fl fl fi
, Relation Between Marginal Utility and Marginal Bene t
In environmental economics (and microeconomics), marginal bene t (MB) is usually measured in
money terms, especially as willingness to pay. Marginal utility (MU) is measured in satisfaction
units. They are closely related: marginal bene t is basically the monetary expression of marginal
utility, because willingness to pay re ects how valuable the next unit feels to you.
That is why your notes say MU and MB are “basically the same,” except MU is usually in abstract
satisfaction units and MB is usually in euros.
Bene ts, Costs, and Marginal Concepts
Economists evaluate decisions using a cost–bene t framework.
• Total bene ts are the sum of all bene ts from an activity.
• Total costs are the sum of all costs from an activity.
However, decisions are made at the margin:
• Marginal bene t (MB) is the additional bene t of one extra unit of an activity. It is often
measured as the maximum willingness to pay (WTP) for that extra unit.
• Marginal cost (MC) is the additional cost of producing one extra unit, including
nancial and opportunity costs (what must be given up).
Environmental economics relies heavily on marginal analysis, because optimal outcomes occur
where marginal bene ts equal marginal costs.
Marginal Analysis
Many environmental questions are: how much production/pollution is optimal and when should
we stop?
The rule is:
• If marginal bene t is greater than marginal cost (MB > MC), producing more increases total
welfare.
• If marginal cost is greater than marginal bene t (MC > MB), producing less increases total
welfare.
• The optimal level of activity is where MB = MC, because this maximizes net social
bene ts (total bene ts minus total costs).
This rule applies to production, consumption, pollution, and resource use.
adam smith – invisible hand
Adam Smith argued that when individuals pursue their own self-interest, markets can lead to
socially optimal outcomes through price signals. This is known as the invisible hand.
In a perfectly competitive market without externalities:
• Prices re ect true costs and bene ts.
• Marginal bene t equals marginal cost.
• Consumer surplus plus producer surplus is maximized.
• Private costs and bene ts equal social costs and bene ts.
However, environmental problems almost always violate these assumptions, mainly because of
externalities.
Demand, Supply, and Market Equilibrium
• The demand curve represents marginal bene ts. Each point shows how much
consumers are willing to pay for one more unit.
• The area under the demand curve equals total bene ts, or total willingness to pay (WTP)
• The supply curve represents marginal costs. Each point shows the cost of producing
one more unit.
• The area under the supply curve equals total production costs.
Market Equilibrium
• Market equilibrium occurs where quantity demanded equals quantity supplied.
• This intersection determines the market price (Pm) and market quantity (Qm).
3
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, • If there are no externalities, this equilibrium is economically e cient because it
maximizes total welfare.
demand shifts when preferences, incomes or substitute prices change
supply shifts when production costs, technology or number of rms change
Economic e ciency
An allocation of resources that maximizes net social bene ts.
Perfect competition without externalities is e cient.
Surplus and welfare
• Consumer surplus (CS) = WTP − Price → example:
WTP €5, price €3 → CS = €2
• Producer surplus (PS) = Price − Cost → example:
price €3, cost €0.50 → PS = €2.50
Total welfare (net social value) in the market: Welfare = CS +
PS
demand & supply (cake example)
willing to pay 5 euro for cake (WTP), cake is 3 euro ⇾
consumer surplus = 2 euro. baker’s costs = 0.50 ⇾ producer
surplus = 2.50 euro
Elasticity (important for tax incidence)
Elasticity measures how responsive quantity is to price
changes.
• Price elasticity of demand measures how much
quantity demanded changes when price changes.
◦ A atter demand curve means demand is more
elastic.
◦ A steeper demand curve means demand is more
inelastic.
• Price elasticity of supply measures how much quantity supplied changes when price
changes.
Elasticity matters because it determines who bears the burden of taxes and how markets
respond to policy.
Why Supply Curves Slope Upward
Supply curves slope upward because of increasing marginal costs:
• In the short run, rms face the law of diminishing returns.
4
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ffi fi ffi fi fiffi
