# Environmental Economics: A Guide to Definitions, Importance, and Examples

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*— Investopedia / Joules Garcia*

## What Is Environmental Economics?

Environmental economics analyzes how we allocate and utilize our limited natural resources efficiently while considering environmental impact. This field aids in crafting policies to balance economic growth with environmental sustainability, addressing issues like externalities and the valuation of public goods.

Economics, broadly speaking, is the study of how humans produce and consume goods and services. Environmental economics examines how we use and manage limited resources to serve the population and address environmental concerns.

This helps governments assess various measures' pros and cons and design suitable [environmental policies](https://www.investopedia.com/terms/i/iso-14000.asp).

### Key Takeaways

*   Environmental economics focuses on assessing the costs and benefits of how natural resources are allocated, used, and protected.  
    
*   Externalities, such as pollution, are a major subject of environmental economics, revealing hidden costs not accounted for by businesses.  
    
*   Market-based approaches, like cap-and-trade and carbon taxes, provide economic incentives to reduce emissions and environmental impact.  
    
*   Effective environmental policies often require international cooperation to address issues that transcend national borders.  
    
*   Environmental economists can work in various roles, including at governmental agencies like the Environmental Protection Agency, to develop and implement sustainability policies.  
    

## The Foundations of Environmental Economics

The basic theory underpinning environmental economics is that environmental amenities (or environmental goods) have economic value and there are costs to economic growth that are not accounted for in more traditional models.

Environmental goods include clean water, clean air, wildlife survival, and the overall climate. Although it is hard to put a price tag on environmental goods, there may be a high cost when they are lost. Environmental goods are usually difficult to fully privatize and subject to the [tragedy of the commons](https://www.investopedia.com/terms/t/tragedy-of-the-commons.asp).

Overuse or destruction of environmental goods, such as pollution, represents [market failure](https://www.investopedia.com/terms/m/marketfailure.asp) due to negative [externalities](https://www.investopedia.com/terms/e/externality.asp). Environmental economists analyze the costs and benefits of policies meant to fix these problems and may conduct tests on potential effects.

> **Fast Fact**
>
> In the United States, any federal project that is likely to affect the environment–such as a highway, dam, or other infrastructure–must publish an environmental impact statement describing any potential risks to the natural environment. These documents are used to assess any negative externalities of the project.

## Approaches and Solutions in Environmental Economics

Environmental economists identify specific problems, but multiple approaches often solve the same issue. If a state is trying to impose a transition to clean energy, for example, they have several options. The government can set carbon emission limits or use incentives like taxes on emissions and [tax credits](https://www.investopedia.com/terms/t/taxcredit.asp) for using renewable energy.

[Mitigation banking](https://www.investopedia.com/articles/dictionary/031615/understanding-basics-mitigation-banking.asp) is a system of credits and debits that ensure ecological loss is compensated through preservation and restoration. Primarily mitigation banking deals with wetland and stream preservation. It is simular to conservation banking which deals with endangered species.

All of these strategies rely on state intervention in the market, but some governments prefer to use a light touch and others may be more assertive. The level of state intervention is a key political factor in shaping environmental economic policy.

Broadly speaking, environmental economics may produce two types of policies:

### Prescriptive Regulations

In a prescriptive approach, the government dictates specific measures to reduce environmental harm. For example, they may prohibit highly-polluting industries, or require certain emissions-controlling technologies.

### Market-Based Regulations

Market-based policies use economic incentives to encourage desired behaviors. For example, cap-and-trade regulations do not prohibit companies from pollution, but they place a financial burden on those who do. These incentives reward companies for reducing their emissions, without dictating the method they use to do so.  

> **Fast Fact**
>
> The Environmental Protection Agency was created by President Richard Nixon in 1970.

## Overcoming Challenges in Environmental Economics

Because the nature and economic value of environmental goods often transcend national boundaries, environmental economics frequently requires a transnational approach. For example, an environmental economist could identify overfishing as a negative externality to be addressed.

The United States could impose regulations on its own fishing industry, but the problem wouldn't be solved without similar action from many other nations. The global character of such environmental issues has led to the rise of [non-governmental organizations](https://www.investopedia.com/ask/answers/13/what-is-non-government-organization.asp) (NGOs) like the Intergovernmental Panel on Climate Change (IPCC), which organizes annual forums for heads of state to negotiate international environmental policies.

Another challenge of environmental economics is the degree to which its findings affect other industries. More often than not, findings from environmental economists can result in controversy, and their policy prescriptions may be difficult to implement due to the complexity of the world market.

The presence of multiple marketplaces for carbon credits is an example of the chaotic transnational implementation of ideas stemming from environmental economics. Fuel economy standards set by the [Environmental Protection Agency](https://www.investopedia.com/terms/e/environmental-protection-agency.asp) (EPA) are another example of the balancing act required by policy proposals related to environmental economics.

In the U.S., policy proposals stemming from environmental economics tend to cause contentious political debate. Leaders rarely agree about the degree of externalized environmental costs, making it difficult to craft substantive environmental policies. The EPA uses environmental economists to conduct analysis-related policy proposals.

These proposals are then vetted and evaluated by legislative bodies. The EPA oversees a National Center for Environmental Economics, which emphasizes market-based solutions like [cap and trade](https://www.investopedia.com/terms/c/cap-and-trade.asp) policies for carbon emissions. Their priority policy issues are encouraging biofuel use, analyzing the costs of climate change, and addressing waste and pollution problems.

## Illustrative Case Studies of Environmental Economics

A prominent contemporary example of the use of environmental economics is the cap and trade system. Companies purchase carbon offsets from developing countries or environmental organizations to make up for their carbon emissions. Another example is the use of a [carbon tax](https://www.investopedia.com/terms/c/carbon-dioxide-tax.asp) to penalize industries that emit carbon.

Corporate average fuel economy (CAFE) regulations are another example of environmental economics at work. These regulations are prescriptive and specify the gallons per mile of gas for cars for car makers. They were introduced during the 1970s to promote fuel efficiency in an era of gas shortages.

## What Is the Difference Between Environmental Economics and Ecological Economics?

Environmental and ecological economics are both sub-fields of economic thought that study the interactions between human activity and the natural environment. The difference is that environmental economics studies the relationship between the environment and the economy, while ecological economics considers the economy to be a subsystem of the wider ecosystem.

## What Is the Relationship Between Neoclassical Economics and Environmental Economics?

[Neoclassical economics](https://www.investopedia.com/terms/n/neoclassical.asp) is a broad theory that focuses on supply and demand as the driving forces of economic activity. Environmental economics is based on the neoclassical model but places a greater emphasis on negative externalities, such as pollution and ecosystem loss.

## What Are Some Jobs in Environmental Economics?

Environmental economists may find ready employment at the Environmental Protection Agency, or other environmental bodies at the state or local level. These specialists are responsible for enforcing regulations to protect the environment and calculating the economic costs of enforcing regulations.

## The Bottom Line

Environmental economics plays a crucial role in understanding the balance between economic growth and environmental protection. It evaluates the economic value of environmental goods, addresses externalities like pollution, and helps design policies such as cap-and-trade systems and carbon taxes to mitigate environmental degradation.

By adopting strategies ranging from prescriptive regulations to market-based incentives, environmental economics seeks sustainable solutions to complex ecological challenges. Scholars, policymakers, and industries must collaborate internationally to address transnational issues like climate change and overfishing, ensuring that environmental policies are both effective and equitable.  

> **Article Sources**
>
> 1.  Environmental Protection Agency. "[The Origins of the EPA](https://www.epa.gov/history/origins-epa)."
>     
> 2.  Environmental Protection Agency. "[About the Office of Policy](https://www.epa.gov/aboutepa/about-office-policy-op)."