Three ways to see the economy

• Neoclassical economics — treats the environment as external to the economy; assumes markets and prices allocate resources efficiently.
• Environmental economics — keeps the market framework but corrects it by pricing environmental costs (externalities) so they enter decisions.
• Ecological economics — sees the economy as a subsystem of the finite biosphere; growth is limited by ecological boundaries, and some natural capital is irreplaceable.

Externalities and market failure

An externality is a cost or benefit of an activity that falls on third parties who are not part of the transaction.

• Negative externality — e.g. a factory’s pollution harms nearby residents but is not in its price.
• Positive externality — e.g. a wetland someone protects benefits everyone downstream.

When prices ignore externalities, markets over-produce polluting goods and under-produce environmental protection — a market failure. The fix is to internalise the externality so the price tells the truth.

Spotting the externality

Your turn — the true social cost

Ecosystem services and natural capital

Nature provides ecosystem services — benefits worth trillions of dollars a year but usually unpriced:

• Provisioning — food, timber, fresh water, medicines.
• Regulating — climate regulation, flood control, pollination, water purification.
• Supporting — soil formation, nutrient cycling, photosynthesis.
• Cultural — recreation, tourism, spiritual and aesthetic value.

Methods to value them include willingness to pay, contingent valuation (surveys) and the cost of replacing the service artificially.

Sort the ecosystem services

Tap a service, then tap the category it belongs to.

Which service is it?

Cost-benefit analysis and discounting

Cost-benefit analysis (CBA) weighs the total costs of a project against its total benefits, including (where possible) environmental ones, to judge whether it is worthwhile.

Discounting reduces the value placed on future costs and benefits. A high discount rate makes long-term environmental damage look cheap today — a serious criticism when the harm (e.g. climate change) falls on future generations.

Your turn — net benefit

Weak vs strong sustainability

• Weak sustainability — assumes man-made capital can substitute for natural capital; what matters is that total capital does not fall (you can replace a forest with the money it earned).
• Strong sustainability — argues some natural capital is critical and irreplaceable (climate stability, biodiversity), so it must be preserved regardless of economic gain.

Neoclassical/environmental economists lean toward weak sustainability; ecological economists insist on strong sustainability.

Weak or strong?

Putting a price on the environment

• Pigouvian tax — a tax set equal to the external cost of pollution, so producers pay for the harm and produce less.
• Subsidies — support for clean technology and behaviour.
• Cap-and-trade — a legal cap on total emissions, with tradable permits so cuts happen where cheapest.
• Payment for ecosystem services (PES) — paying landowners to maintain services, e.g. protecting forests that supply a city’s water.

Your turn — a Pigouvian tax

Rewarding protection

Beyond GDP

Gross domestic product (GDP) measures the value of goods and services produced, but it is a poor gauge of wellbeing or sustainability:

• It counts pollution clean-up and disaster rebuilding as gains.
• It ignores resource depletion and unpaid work.
• It says nothing about how income is distributed.

Alternatives include the Genuine Progress Indicator (GPI), green GDP (subtracting environmental costs), and the Human Development Index.

The trouble with GDP

Match the economics terms

Tap a statement on the left, then its matching answer on the right.

The big ideas to know

You now have the economics lens to argue how markets and prices shape the environment. Press Finish to see your score.