Scenarios and Policy Implications
The Fondazione Eni Enrico Mattei series on Economics, the Environment and Sustainable Development
Edited by Anil Markandya, Andrea Bigano and Roberto Porchia
Chapter 1: External Costs
Luke Brander, El Hadji Fall, Rainer Friedrich, Stefan Hirschberg, Onno Kuik, Kristin Magnussen, Ståle Navrud, Philipp Preiss, Ari Rabl and Bob van der Zwaan 1.1 EXTERNALITIES AND EXTERNAL COSTS Externalities exist in the form of external costs and external benefits. External costs occur when an economic subject causes a loss in welfare to another one and does not compensate this change. A compensation for this change in welfare due to external costs would eliminate the market imperfection caused by externalities. This procedure is called internalisation of externalities because external costs are considered in market mechanisms. In a situation where all externalities are internalised there is no longer any relevant externality, although there are, of course, still emissions and damages. For example, a cost–benefit analysis requires the estimation of the marginal damage costs (MDC) and marginal avoidance costs (MAC). These values should be equal in order to determine the optimum instruments and, therefore, the optimum total emissions. A reasonable and practicable dimension which enables the comparison of costs and benefits are monetary values. Therefore, the impact pathway approach is used in order to estimate the costs of emissions and benefits of emission reduction. The costs reveal the preferences of the society, that is the willingness to pay to avoid the risk of these damages. With this assessment method, a general path from emissions to the external costs and benefits in the reduction of emissions is followed to estimate them as transparently, consistently and comprehensively as possible. External Costs per...
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