government planners, and scientists support replacing
GDP and NDP with a more comprehensive measure of
national income accounting that includes estimates of
both depletion of natural capital and the environmental
cost of economic activities (Figure 3.16).
An Economist’s View of Pollution
An important aspect of the operation of a free-market
system is that the person consuming a product should
pay for all the cost of producing
it. However, production or con-
sumption of a product often has
an e xternal cost.
A product’s market price
does not usually reflect an ex-
ternal cost—that is, the buyer or
seller doesn’t pay for all of the
costs associated with production.
As a result, a market system with externalities generally
does not operate in the most efficient way.
Consider the following example of an external cost.
If an industry makes a product and, in so doing, also
releases a pollutant into the environment, the product
is bought at a price that reflects the cost of inputs such
as labor, energy, buildings, and raw materials. However,
the price does not reflect costs from when pollutants
damage the environment, which is the external cost
of the product. (One common external cost of many
products is air pollution released when fossil fuels are
burned to transport manufacturing components or fin-
ished goods.)
Because this environmental damage is not included
in the product’s price and because the consumer may
not know that the pollution exists or that it harms the
environment, the cost of the pollution has no impact on
the consumer’s decision to buy the product. As a result,
consumers of the product may buy more of it than they
would if its true cost, including the cost of pollution, were
reflected in the selling price.
The failure to add the price of environmental
damage to the cost of products generates a market
force that encourages pollution. From the perspective
of economics, then, one of the causes of the world’s
pollution problem is the failure to include external costs
in the prices of goods.
We now examine industrial pollution from an econo-
mist’s viewpoint, as a policymaking failure. Keep in mind,
Waterfall in Great Smoky Mountain National
*>ÀÊUÊ}ÕÀiÊΰ£ÈÊ
Resources removed from pristine areas such as this one would
not be counted as a loss in standard national income accounting.
Photographed in North Carolina.Tim Fitzharris/NG Image Collectionexternal cost
A harmful
environmental or
social cost that is
borne by people not
directly involved in
selling or buying a
product.however, that lessons about the economics of industrial
pollution also apply to other environmental issues (such
as resource degradation) where harm to the environ-
ment is a consequence of economic activity.How Much Pollution Is Acceptable? Econom-
ics entails trying to get the most goods or services
from limited resources. Consequently, economic solu-
tions to environmental harm view that harm as a loss
of resources, a loss that can be assessed in monetary
terms. For example, if a coal mining operation pollutes
a well that was previously used for drinking water, the
economic loss would be equal to the cost of provid-
ing clean drinking water to the people who previously
drank from the well.Environmental Economics 65