External Costs

A great deal of man-made residue and emissions is connected with the energy economy—from extraction, transformation, and transportation on to the final use of energy. Concepts have been developed in environmental economics for solving the associated problems in an economically efficient way. They revolve around the terms externality, external cost, and avoidance cost (also called abatement cost). Provided damages and risks can be quantified and monetized, internalization strategies are available which shift external costs back to the consumers of energy in the guise of higher energy prices. Market participants are made to extend their avoidance effort to the point where the marginal abatement cost equals marginal damage cost avoided. This is the social optimum. While these lines of thought look conceptually simple enough, there are several issues that need to be addressed: How can externalities be linked to specific emissions? How are they to be quantified and expressed in money as to become external costs? Frequently, marginal external cost avoided cannot be easily measured, as e.g. in the case of improved air quality. How is one to proceed for determining the optimum? An economic expression of the marginal benefit of avoidance is (marginal) willingness to pay of those affected by the externality. Are there ways to measure this? So-called market experiments have become popular for estimating willingness to pay. How can they be performed? What are their limitations? The so-called standard-price constitutes an alternative. In what circumstances is it to be recommended?