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Economic Theory for the Environment

Essays in Honour of Karl-Göran Mäler

Edited by Bengt Kriström, Partha Dasgupta and Karl-Gustaf Löfgren

Karl-Göran Mäler’s work has been a mainstay of the frontiers of environmental economics for more than three decades. This outstanding book, in his honour, assembles some of the best minds in the economics profession to confront and resolve many of the problems affecting the husbandry of our national environments.
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Chapter 11: Valuing Ecosystem Services

Geoffrey Heal


Geoffrey Heal* The services of natural ecosystems are clearly very important to our societies: we probably could not live without them. (For a review of the importance of ecosystem services, see Daily 1997.) Does this importance translate into economic value? Are these services very valuable in an economic sense? Intuitively it may seem that the answer must be yes. In fact the matter is not so simple as our intuition suggests. Economics is more concerned with prices than with values or importance. To delve into these issues, we need to begin with a discussion of exactly what prices are and what they reflect. For a start, we need to be clear that the price of a good does not reflect its importance in any overall social or philosophical sense. Very unimportant goods can be valued more highly by the market than – have higher prices than – very important goods. The classic illustration of this is the diamonds and water paradox, which perplexed economists through the eighteenth and nineteenth centuries until its resolution by Alfred Marshall. The point here is that water is clearly more important to human society than diamonds, yet diamonds trade in the market at prices far in excess of those fetched by water. Why? Marshall’s answer was simple and is by now part of common knowledge: price is set by supply and demand. The market price is the price at which the amount supplied is also the amount demanded. In the case of water, the supply (at least...

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