HL.b Environmental economics

Learning objectives

• Outline what economics studies and how supply and demand set prices in a free market.

• Distinguish between environmental economics and ecological economics, and relate each to environmental value systems.

• Explain market failure and negative externalities, and draw and annotate an externality diagram.

• Evaluate the polluter-pays principle and its tools: quotas, fines, taxes, tradeable permits and carbon-neutral certification.

• Explain greenwashing and suggest how it can be recognised and regulated.

• Explain how unclear property rights lead to the tragedy of the commons, and how community management can prevent it.

• Distinguish use and non-use values, and outline how willingness to pay and willingness to accept are used to value them.

• Evaluate attempts to value ecosystem services and natural capital, including environmental accounting and payments for ecosystem services.

• Define economic growth and per capita GDP, and discuss the positive and negative environmental effects of growth.

• Distinguish between absolute and relative decoupling, and interpret data on GDP and emissions.

• Discuss degrowth and zero-growth models, the circular economy and doughnut economics as applications of ecological economics.

• Apply the environmental economics lens to issues from every topic of the course.

Introduction

Almost every environmental problem has an economic side. Forests are cleared because cattle or soy earn more than standing trees; rivers are polluted because dumping waste is cheaper than treating it; fish stocks collapse because no single fisher gains by catching less. Environmental economics studies why markets produce these outcomes and which tools can change them.

The lens connects directly to the three foundation ideas of the course. Different perspectives lead to different kinds of economics: a technocentric view trusts markets and technology to fix environmental damage, while a more ecocentric view questions whether endless growth is possible on a finite planet. A systems view treats the economy as a set of flows of energy and matter that depend on the biosphere. Sustainability asks whether those flows can continue for the long term without running down natural capital.

What economics studies

Every society has to decide what to produce, how to produce it and who gets it. Land, water, minerals, labour and time are limited, while human wants are not, so choices always involve giving something up. Economics is the study of these choices.

Economics looks at choices at two scales. Individual households and firms decide what to buy, what to sell and at what price. Whole countries decide how much to spend on schools, roads or nature reserves, and how to tax and regulate. Environmental issues appear at both scales, from a farmer choosing a fertiliser to a government choosing an energy policy.

Markets, supply and demand

A market is any arrangement in which buyers and sellers exchange a good or service, from a village fish market to the global oil trade. In a free market, prices are set by the interaction of buyers and sellers rather than by the government. Price works as a signal: a rising price tells producers to make more and consumers to use less.

The model of supply and demand explains how this signal works. At a high price, sellers offer more timber than buyers want, so unsold stock builds up and sellers cut the price. At a low price, buyers want more than is offered, so sellers can raise the price. The price moves until the quantity supplied equals the quantity demanded, which is the market equilibrium.

Markets are very good at some things. They use the knowledge of millions of buyers and sellers, reward producers who cut costs, and adjust quickly when conditions change. When a resource becomes scarce, its price rises, which encourages users to save it and inventors to find substitutes. The sharp rise in the price of oil after 1973, for example, encouraged more fuel-efficient cars and the search for new oil fields.

The model rests on assumptions, however. It assumes that every cost and benefit of a product is included in its price, that everything valuable is owned by someone who can sell it, and that buyers have full information. Environmental goods often break all three assumptions. Clean air has no owner and no price, the damage done by pollution is not paid by the polluter, and consumers rarely know how a product was made.

Environmental economics and its perspectives

Environmental economics grew out of mainstream economics in the 1960s and 1970s, when pollution became a political issue in industrial countries. It accepts the market system and economic growth, and asks how prices, taxes and property rights can be adjusted so that markets take account of the environment. Its main tools are putting a price on pollution, valuing natural resources in money, and comparing the costs and benefits of protecting them.

The approach fits a broadly technocentric and anthropocentric value system. It assumes that science and technology, guided by the right prices, can solve environmental problems without changing the basic structure of the economy. Nature is valued mainly for what it provides to people, and losses of natural capital can in principle be made up by gains in other kinds of capital, a position known as weak sustainability.

A second school, ecological economics, starts from the opposite end. It treats the economy as a small part of the biosphere, limited by the energy and materials that the Earth can supply and the wastes it can absorb. Ecological economists tend to hold more ecocentric values, and they are more willing to question growth itself. Most real policies borrow from both schools.

Market failure and externalities

A market works well when the price of a product reflects everything it costs society to make it. A paper mill pays for wood, energy, machines and wages, and passes these costs on in the price of paper. If the mill also releases waste into a river, the fish die and towns downstream pay to clean their drinking water. These costs are real, but they do not appear in the mill's accounts or in the price of paper.

Market failure is one of the most important ideas in environmental economics, because most environmental damage is a form of it. The market does exactly what it is designed to do, matching buyers and sellers at a price, but the price is wrong. Too much of the polluting product is made and sold, because part of its cost is paid by people who are not in the market at all.

An externality can be negative (an external cost) or positive (an external benefit). Pollution is the classic negative externality: the smoke from a coal power station damages the lungs of people living downwind and the climate of the whole planet. A positive externality arises when a farmer plants hedgerows that shelter pollinators for neighbouring farms, or when a forest owner keeps trees that store carbon and regulate rainfall for everyone.

The externality diagram

The externality diagram shows the size of the problem. The marginal private cost (MPC) curve is the cost to the firm of producing one more unit, and it forms the market supply curve. The marginal social cost (MSC) curve adds the external cost to the MPC, so it lies above it. The demand curve shows the benefit of each unit to buyers; where there is no external benefit, it equals the marginal social benefit (MSB).

The market settles where supply (MPC) meets demand, at quantity Qm and price Pm. The socially best quantity, Q*, is where MSC meets demand, because at that point the benefit of the last unit equals its full cost to society. The market overproduces (Qm is greater than Q*) and underprices (Pm is lower than P*). The shaded triangle is the welfare loss: the net harm caused by units that cost society more than they are worth.

A tax that equals the external cost is called a Pigouvian tax, after the economist Arthur Pigou, who described the idea in 1920. In practice the external cost is hard to measure, because it depends on where the pollution goes, how many people it reaches and how the damage is valued. Governments therefore set taxes by estimate and adjust them over time.

Sources: Wikipedia, "Pigouvian tax" (read October 2026).

The Great Smog of London in December 1952 is a historical example of a huge unpriced external cost: smoke from coal burned in homes, factories and power stations killed about 4,000 people within days and, by modern estimates, 10,000–12,000 in total, yet no household or factory paid for the harm. Climate change is the largest externality of all, because every tonne of CO₂ emitted anywhere imposes costs on people everywhere, including future generations who have no say in today's markets.

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The polluter-pays principle

If market failure happens because polluters do not pay for the damage they cause, the obvious correction is to make them pay. This idea has become a guiding principle of environmental policy in many countries and in international agreements; it is Principle 16 of the Rio Declaration on Environment and Development (1992).

The polluter-pays principle has two aims. The first is fairness: the costs of pollution should fall on those who benefit from the polluting activity, not on neighbours, taxpayers or future generations. The second is efficiency: once pollution costs money, polluters have a reason to find cheaper ways of producing less of it. In terms of the externality diagram, the principle "internalises" the external cost, moving the private cost up to the social cost.

The principle has limits. Some pollution comes from millions of small sources (cars, farms, households) rather than a few factories, so identifying the polluter is hard. Some damage, such as an extinct species or a collapsed fishery, cannot be undone at any price. And firms that pay may pass the cost on to consumers, including poor households who spend a large share of their income on fuel and food.

Tools for making polluters pay

Governments use several tools, which fall into two broad groups. Command-and-control tools set rules and punish those who break them; market-based tools change prices and leave each polluter to decide how to respond.

A green tax puts the polluter-pays principle into practice most directly. Its effect depends on how responsive buyers and sellers are to the higher price. A charge on single-use plastic bags changes behaviour quickly because shoppers can easily bring their own bags; a tax on petrol changes behaviour slowly, because many people have no alternative to driving in the short term. Revenue from green taxes can be returned to households, spent on clean alternatives or used to cut other taxes.

Carbon taxes and emissions trading as economic tools

Greenhouse gas emissions are the externality that most countries now try to price. A carbon tax fixes the price of each tonne of CO₂ and lets the market decide how much is emitted. Emissions trading (cap and trade) fixes the quantity, by issuing a limited number of permits, and lets the market decide the price. Both put the polluter-pays principle into practice; they differ in which number the government controls.

Sweden introduced one of the first carbon taxes in 1991 and now has one of the highest carbon prices in the world. British Columbia, in Canada, introduced a carbon tax in 2008 that started at 10 Canadian dollars per tonne and rose to 80 dollars by 2024. It was designed to be revenue-neutral: the money raised was returned through cuts in income and business taxes and a tax credit for low-income households. Studies found that it reduced fuel use without measurable harm to economic growth.

Political support proved fragile. The consumer carbon tax was unpopular with many voters as living costs rose, and in March 2025 the new Canadian prime minister, Mark Carney, ended the federal consumer fuel charge, which fell to zero from 1 April 2025. British Columbia repealed its own consumer carbon tax from the same day, after 17 years. Carbon pricing for large industrial emitters continued. The case shows that an economically efficient tool can fail if the public does not see it as fair.

Sources: Wikipedia, "British Columbia carbon tax", "Carbon pricing in Canada" and "Carbon tax" (read October 2026).

Emissions trading has spread faster than taxes. The EU Emissions Trading System, the first large scheme, started in 2005; China launched a national scheme for its power sector in 2021, which at once made it the largest in the world by emissions covered. By 2025, 80 carbon pricing instruments were in operation, and around 28% of global greenhouse gas emissions were covered by a carbon price, up from 12% a decade earlier. Revenues from carbon pricing exceeded US$100 billion in 2024.

Sources: World Bank, State and Trends of Carbon Pricing 2025 (press release, June 2025).

Coverage alone says little about effect, because the price matters too. A price of a few dollars per tonne barely changes behaviour, while a price above US$100 makes coal power and many fossil-fuel uses uneconomic. Prices vary enormously between countries, and the global average on covered emissions is only about US$22 per tonne.

Greenwashing

As consumers and investors become more concerned about the environment, companies have a strong incentive to appear green. Real change, such as redesigning a product or closing a coal mine, is expensive, while advertising costs far less. When a company spends money on appearing sustainable instead of changing its practices, consumers and investors are misinformed.

Greenwashing is an economic problem as well as an ethical one. A market only rewards greener products if buyers can tell which products are greener. When claims are vague or false, consumers who want to pay more for sustainable goods cannot do so, and honest firms lose out to those that only advertise. The information failure weakens the price signal that environmental economics depends on.

Examples of greenwashing

• Oil companies and clean energy: around 2000 BP rebranded itself with a green and yellow sunburst logo and the slogan "Beyond Petroleum", while oil and gas remained its core business; it cut back its alternative energy business after 2011, and in 2025 it announced lower investment in renewables and higher spending on oil and gas. Critics describe many later campaigns by oil companies, which present a transition to clean energy while spending far more on fossil fuels, in the same way.

• Volkswagen's "clean diesel": Volkswagen advertised its diesel cars as clean and efficient. In September 2015 the US Environmental Protection Agency found that software in about 11 million cars worldwide detected emissions tests and switched on pollution controls only during testing; on the road, the cars emitted up to 40 times the legal limit of nitrogen oxides. The scandal cost the company about US$33 billion by 2020 in fines, settlements and buybacks.

• Vague product claims: a European Commission screening of websites in 2021 found that in 42% of cases green claims were likely to be false or misleading. Words such as "eco-friendly", "natural" or "climate neutral" are often used without evidence.

Sources: Wikipedia, "Greenwashing" and "Volkswagen emissions scandal" (read October 2026).

Regulators have started to respond. The United Kingdom's Competition and Markets Authority published a Green Claims Code in 2021, and an EU directive on empowering consumers for the green transition (Directive 2024/825) bans generic environmental claims, such as “eco-friendly”, that cannot be proved, and claims that a product is carbon neutral because its emissions are offset. Its rules have applied across the EU since 27 September 2026. Such laws show the HL lenses working together: law sets the rules on information so that the market can reward real environmental performance.

Property rights and the tragedy of the commons

Markets work only for things that someone owns. An owner can sell a resource, charge for its use and keep others out, so the owner has a reason to look after it. Many environmental goods have no owner: the open ocean, the atmosphere, groundwater in many countries, or a pasture shared by a village.

Where property rights are unclear and no market price is attached to a shared resource, each user gains the full benefit of taking a little more, while the cost of overuse is spread across everyone. This is the logic of the tragedy of the commons, described by Garrett Hardin in the journal Science in 1968: rational individual decisions add up to the destruction of a shared resource. The collapse of the northern cod fishery off Newfoundland in 1992 is a classic case of market failure of this kind, because no fishing fleet gained anything by leaving cod in the sea for others to catch.

Free-market economists have usually proposed one of two solutions. The first is privatisation: give each user a clear share of the resource, such as a fenced plot or an individual transferable fishing quota, so that the owner has an incentive to conserve it. The second is state control: a government owns the resource and sets limits on its use. Both have weaknesses. Privatisation can push poorer users out, as the enclosure of common land in England did, and state control often fails where governments lack the money or local knowledge to enforce rules.

Ostrom and community management

The American political economist Elinor Ostrom showed that there is a third way. In Governing the Commons (1990) she studied shared resources that communities had managed sustainably for centuries without privatisation or state control: mountain pastures and forests in Switzerland and Japan, irrigation systems in Spain and the Philippines, and inshore fisheries. In 2009 she became the first woman to receive the Nobel Memorial Prize in Economic Sciences, shared with Oliver Williamson.

Her best-known case is Törbel, a village in the canton of Valais in the Swiss Alps. Its farmers own their own meadows and fields, but the high summer pastures and forests are owned and managed in common. Villagers formed an association to regulate the alp, forests and waste lands in 1483, and rules written in 1517 state that no citizen may send more cows to the summer pasture than he can feed through the winter. A local official enforces this “wintering” rule and fines anyone who grazes more cows than allowed.

From cases like these, Ostrom identified eight design principles shared by long-lasting commons institutions:

• clearly defined boundaries for the resource and for who may use it;

• rules that fit local conditions;

• users take part in making and changing the rules;

• monitors who are accountable to the users;

• graduated sanctions, which grow with the seriousness of the offence;

• cheap, local ways of resolving conflicts;

• outside authorities recognise the community's right to organise;

• for larger systems, nested layers of governance.

Sources: Ostrom, Governing the Commons (1990); Wikipedia, "Elinor Ostrom" and "Tragedy of the commons" (read October 2026).

Ostrom's work shows that the tragedy of the commons describes a limitation of free-market thinking and does not happen everywhere. Where users know each other, can communicate and trust that others will follow the rules, communities can manage commons sustainably. Her principles are harder to apply to global commons such as the atmosphere or the high seas, where billions of users never meet, which is one reason why international agreements remain necessary.

Putting a value on nature

Markets and governments make decisions in money. A new road, a mine or a dam is approved when its benefits appear to exceed its costs, and those benefits are usually counted in money. If a wetland or a forest has no price, it is counted as worth nothing and is easily sacrificed. Environmental economists therefore try to attach money values to natural resources and to the services they provide.

Environmental accounting

National accounts measure the output of an economy as gross domestic product (GDP). Standard GDP counts timber sold from a forest as income, but it does not subtract the loss of the forest itself. A country that cuts down all its forests, exhausts its fish stocks and pollutes its rivers can show strong GDP growth while its natural wealth falls, like a business that counts the sale of its machines as profit.

Environmental accounting tries to correct this. At national level, the UN System of Environmental-Economic Accounting (SEEA) was adopted as an international statistical standard in 2012, and a standard for ecosystem accounting followed in March 2021. Countries compile physical accounts (tonnes of timber, cubic metres of water, hectares of each ecosystem) and, where possible, money values. Green GDP, which subtracts environmental costs from GDP, is one result of this approach; China's attempt to publish it in the 2000s showed how politically sensitive the figures can be.

Sources: Wikipedia, "System of Environmental-Economic Accounting" (read October 2026).

Environmental accounting faces a deep problem: different stakeholders value the same resource very differently. A logging company values a forest for its timber, a downstream city for its water, a tourist for its beauty, an Indigenous community for its cultural and spiritual meaning, and a conservationist for its species. Agreeing a single value that all of them accept is rarely possible, so any figure reflects choices about whose values count.

Use values and non-use values

Economists group the ways in which people value nature into a framework called total economic value. Some values come from using the resource; others do not involve any use at all.

Use values are the easiest to measure, because many of them have market prices. The price of timber, the income from fishing licences or the money that tourists spend on a visit all give an estimate. Indirect use values have no price, but they can sometimes be estimated by the cost of replacing them: the cost of building flood defences gives a value for a wetland that absorbs floodwater.

Non-use values have no market at all. Many people value the survival of blue whales or of the Amazon rainforest without ever expecting to see them. Three types are usually named:

• Existence value: the value of knowing that a species or place exists, close to the idea of intrinsic value expressed in money.

• Option value: the value of keeping a resource for a possible future use, such as a plant that may one day yield a medicine. Because no use happens yet, it is grouped with non-use values in some frameworks and with use values in others.

• Bequest value: the value of passing a resource on to future generations.

Because non-use values have no price, economists ask people directly. A contingent valuation survey describes a scenario, such as a plan to protect a coastline from oil spills, and asks respondents their willingness to pay for it. An alternative question asks their willingness to accept compensation for the loss of the good. Average answers are then multiplied by the number of households affected to give a total value.

Willingness to accept is usually much higher than willingness to pay for the same good, partly because people value what they already have more than what they might gain, and partly because WTA has no budget limit. For this reason a panel of economists chaired by Kenneth Arrow and Robert Solow, set up by the US National Oceanic and Atmospheric Administration, recommended in 1993 that surveys ask about willingness to pay, which gives cautious, lower estimates.

Exxon Valdez: valuing what was lost

On 24 March 1989 the tanker Exxon Valdez struck Bligh Reef in Prince William Sound, Alaska, and spilled about 10.8 million US gallons of crude oil. Oil reached about 2,100 km of coastline, and between 100,000 and 250,000 seabirds, at least 2,800 sea otters and 247 bald eagles died. Exxon spent about US$2 billion on the clean-up. Most of the people who valued Prince William Sound had never been there, so the market value of lost fishing and tourism covered only part of the damage.

The State of Alaska funded a large national contingent valuation survey to estimate this lost non-use (passive-use) value: households across the United States were asked how much they would pay to prevent a similar spill. It was the first time that such surveys were used in a quantitative assessment of damages.

Multiplying the median answer by the number of households gave about US$2.8 billion (in 1990 dollars), which the researchers treated as a cautious lower bound. Exxon later settled the government lawsuits for about US$1 billion in natural resource damages, on top of its clean-up spending. The spill also led to the US Oil Pollution Act of 1990, and the debate over the survey shaped the 1993 panel's standards for contingent valuation.

Sources: Wikipedia, "Exxon Valdez oil spill" and "Contingent valuation" (read October 2026); Carson et al., _Environmental and Resource Economics (2003)._

Cost–benefit analysis is where valuation is used most often. It makes environmental losses visible in the same units as economic gains, so a wetland is no longer counted as worth nothing. Its weaknesses are the weaknesses of valuation itself: some losses (an extinction, a sacred site) cannot meaningfully be priced, future benefits are usually discounted so that they count for less than present ones, and the outcome depends on whose willingness to pay is measured. Wealthy people can pay more, so their preferences weigh more heavily.

Valuing ecosystem services

Ecosystem services are the benefits people obtain from ecosystems, such as food, clean water, pollination, climate regulation and recreation. Most of them are free, so they are invisible in markets. Valuing them is a central aim of ecological economics, which argues that decisions will go on destroying natural capital until its services appear in the accounts.

In 1997 Robert Costanza and colleagues published the first global estimate: the world's ecosystem services were worth between US$16 and 54 trillion per year, with an average of about US$33 trillion, more than the total output of the world economy at the time. A 2014 update by the same team estimated the value in 2011 at about US$125 trillion per year, and the loss from land-use change since 1997 at US$4.3–20.2 trillion per year.

The numbers made headlines and showed the scale of what markets ignore, but critics pointed out that the total value of services on which all life depends is in a sense infinite, so any single figure is more a statement of importance than a usable price.

Valuation is most useful for specific local decisions. In the 1990s New York City faced building a water filtration plant estimated at US$6–8 billion, plus about US$300 million a year to run. Instead, it spent an estimated US$1–1.5 billion protecting the Catskill Mountains watershed, buying land and paying farmers to reduce pollution, so that the forests and soils kept filtering the city's water at a fraction of the cost of the technological replacement.

Sources: Wikipedia, "Ecosystem service" (read October 2026); Costanza et al., _Global Environmental Change (2014)._

Payments for ecosystem services

Payments for ecosystem services turn the polluter-pays principle round into a "beneficiary pays" principle. Instead of charging those who damage nature, they reward those who protect it. A city may pay upstream farmers to keep forest on steep slopes; a hydropower company may pay for reforestation to reduce silt in its reservoir. Costa Rica runs the best-known national scheme, analysed in the case study.

Paying other countries not to deplete their natural capital

Ecological economics places even more weight on valuing ecosystem services, and the idea now operates between countries. Countries whose own forests were cleared long ago, sometimes called "resource-depleted", pay "resource-rich" developing countries to keep forests standing, because those forests store carbon, regulate rainfall and hold biodiversity that benefit the whole world. The value counted goes beyond timber to services, tourism and aesthetic value, and ethical value.

Sources: Wikipedia, "Yasuní-ITT Initiative", "Tropical Forest Forever Facility" and "Amazon Fund" (read October 2026).

These schemes create tensions between countries. Forest nations argue that rich countries became rich by clearing their own forests and burning fossil fuels, so paying for conservation is a matter of justice rather than charity. Donor countries want proof that their money buys real results. Some governments see conditions attached to payments as interference in national decisions, while Indigenous groups ask whether money reaches the people who actually protect the forest. The Yasuní failure showed that voluntary payments rarely match the value of the resource left in the ground.

Ecological economics

Ecological economics was founded as a separate field in the late 1980s; the International Society for Ecological Economics and its journal Ecological Economics date from 1989, with Robert Costanza as the first president. Its thinkers, including Herman Daly and Nicholas Georgescu-Roegen, drew on physics and ecology as much as on economics. Their starting point is that the economy is a physical system that takes in energy and materials and gives out wastes.

Seen as a system, the biosphere receives an input of solar energy, which drives photosynthesis, the water cycle and the climate. These processes sustain the energy and material resources (food, timber, water, fossil fuels, minerals) that enter the economic subsystem. Inside the economy they are transformed into goods and services, and they leave as wastes and, finally, as low-grade heat, which is lost to space. Because energy is degraded at each step, no economy can recycle its way to unlimited growth.

The nested diagram is the same picture as the strong sustainability model: the economy depends on society, and society depends on the environment. It leads ecological economists to three positions that set them apart from environmental economics.

• Scale matters. Getting prices right is not enough if the whole economy is too large for the biosphere. Limits on total resource use and pollution come first, and markets work within them.

• Natural capital cannot simply be replaced. Ecological economics values natural capital alongside manufactured capital (machines, buildings, roads), human capital (skills, knowledge, health) and financial capital (money and investments), but treats some natural capital, such as a stable climate or fertile soil, as critical and irreplaceable.

• Act with precaution. Because ecosystems can cross tipping points and damage may be irreversible, ecological economics applies the precautionary principle: where there is a threat of serious harm, lack of full scientific certainty is not a reason to delay action.

The four kinds of capital make the difference between the two schools concrete. An environmental economist may accept selling a forest (natural capital) to build a factory (manufactured capital) if the factory produces more value. An ecological economist asks whether the forest provides services, such as rainfall or flood control, that no factory can replace, and whether the society can survive without them.

Financial capital, the money and financial assets used to buy the other kinds, is the only one that can be created at will by banks and governments. Ecological economists warn that confusing it with real wealth hides the depletion of the natural capital on which everything else depends.

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Economic growth

Most governments aim for economic growth, and growth is usually reported every three months in the news. It is worth being precise about what it measures. Gross domestic product is the total market value of all the final goods and services produced in a country in a period, usually a year.

Total GDP is large in countries with many people, so per capita GDP is a better measure of living standards. It is still only an average: it says nothing about how income is shared. Two countries with the same per capita GDP may differ greatly if in one of them most income goes to a small wealthy group.

Growth as a measure of prosperity

Growth is driven by supply and demand: more people, more investment, new technology and rising incomes increase both what can be produced and what people want to buy. Governments value it because it creates jobs, raises tax revenue and has lifted hundreds of millions of people out of poverty. For these reasons growth is widely perceived as the main measure of prosperity.

Most growth so far has followed a linear economy: resources are extracted, made into products, used and thrown away. GDP counts the extraction and the production, but not the waste, the pollution or the degraded land left behind. A linear economy that keeps growing therefore keeps increasing its demands on the planet, unless the link between output and environmental damage is broken.

Positive and negative effects of growth on the environment

Growth also raises questions of environmental justice. The benefits of rising consumption go mostly to those who consume, while the costs (mines, polluting factories, waste dumps, climate impacts) often fall on poorer communities, Indigenous peoples, people in other countries and future generations. A country's growth may be "clean" at home because its polluting industries have moved abroad.

The environmental Kuznets curve

The environmental Kuznets curve, proposed by economists in the early 1990s, offers an optimistic view of growth. In poor agricultural societies pollution is low; as they industrialise, pollution rises; once incomes are high, people demand a cleaner environment, the economy shifts to services, and regulation and cleaner technology bring pollution down. The evidence supports this pattern for several local pollutants, such as sulfur dioxide, lead and sewage, which have fallen in many rich countries.

The hypothesis has serious limits. It works best for local, visible pollution whose damage falls on the voters who pay for the clean-up. Global problems such as CO₂ emissions do not follow it well, because the costs fall on other countries and future generations. Part of the fall in rich countries also comes from moving polluting industries to poorer countries, which cannot all repeat the trick. The hypothesis also ignores irreversible losses, such as extinctions, that happen on the rising side of the curve.

Sources: Wikipedia, "Kuznets curve" (read October 2026).

Decoupling

If growth increases environmental damage, the question is whether the two can be separated. Decoupling means that GDP keeps growing while environmental pressure (resource use, emissions or pollution) grows more slowly or falls. Its two forms must be kept apart.

A car that uses 20% less fuel per kilometre shows relative decoupling of fuel use from distance driven; if people drive 30% further, total fuel use still rises.

Relative decoupling is common: almost every economy now emits less CO₂ per dollar of output than it did decades ago, because of more efficient machines and cleaner energy. Absolute decoupling is much harder, because efficiency gains must outpace growth. Sustainability depends on absolute decoupling, since the environment responds to total pressure, not pressure per dollar.

What the data show

Sources: Global Carbon Budget (2025) and Maddison Project Database, via Our World in Data, "CO₂ and greenhouse gas emissions" dataset (downloaded October 2026).

The UK, Sweden and several other high-income countries show absolute decoupling of CO₂ from GDP, mainly by replacing coal with gas and renewable electricity and by the decline of heavy industry. Whether this can go far enough and fast enough is fiercely debated. Ecological economists argue that absolute decoupling of all resource use from growth, sustained indefinitely, is impossible: an economy that grows by 3% a year doubles in size every 23 years, so efficiency would have to keep improving faster for ever. Technocentric economists reply that a growing share of output is services and information, which need few materials, and that technology such as cheap solar power can make deep decoupling possible.

Degrowth, zero growth and the steady-state economy

If absolute decoupling cannot be achieved fast enough, ecological economists conclude that rich countries must stop growing, or even shrink, their use of materials and energy. This conclusion leads to two related ideas.

The steady-state economy is associated with the American ecological economist Herman Daly, who promoted it from the 1970s. Daly described it as an economy with a constant stock of physical wealth and a constant population, maintained by a flow of resources that stays within what ecosystems can regenerate and absorb. Development (improvement in quality, knowledge and well-being) can continue; growth in physical throughput cannot. Zero growth and slow growth are versions of the same idea.

Degrowth goes further. Its supporters, including the economists Giorgos Kallis and Jason Hickel, argue that high-income countries already consume far more than their share of the planet's biocapacity, and that they should deliberately reduce material consumption so that poorer countries can still grow to meet basic needs. Proposals include shorter working weeks, universal basic services, limits on advertising, longer-lasting products and taxing very high incomes and wealth. The goal is that each country's ecological footprint balances its biocapacity, rather than that GDP keeps rising.

Humanity's 21st century challenge is to meet the needs of all within the means of the planet.

— Kate Raworth, quoted in Wikipedia, "Doughnut (economic model)" (read October 2026)

Difficulties of slow, zero or degrowth

• Embedded systems. Pensions, government debt, employment and business investment all assume growth. When growth stops unplanned, as in a recession, unemployment and poverty rise, so a planned transition would need a deep redesign of these systems.

• Measuring well-being. Replacing GDP as the target needs objective measures of social and environmental well-being, such as health, education, equality, footprint and biocapacity, and there is no agreement on which to use or how to weight them.

• Political feasibility. Few voters choose lower consumption, and critics argue that degrowth is politically unrealistic; they prefer "green growth" through carbon pricing and clean technology.

• Poverty and fairness. Critics warn that a shrinking economy has never benefited the poorest. Degrowth supporters reply that the plan applies to high-income countries, while low-income countries still need to grow.

Sources: Wikipedia, "Degrowth" and "Steady-state economy" (read October 2026).

The circular economy and doughnut economics as applied ecological economics

Two models from the study of sustainability, the circular economy and doughnut economics, can be seen as ecological economics put into practice. Both accept that the economy must work within the limits of the biosphere, and both try to show what such an economy would look like.

The circular economy and product stewardship

The circular economy replaces the linear take–make–dispose model with loops in which products, parts and materials are kept in use for as long as possible, and biological materials return safely to the soil. In economic terms, it tries to cut the throughput of new materials and the output of waste for each unit of value, which is a strategy for decoupling. Its effectiveness varies: recycling rates for many materials remain low, and growth in total consumption can outpace the savings from circular design.

Product stewardship spreads responsibility for a product across its life. Manufacturers design products that last and can be repaired and recycled, retailers take back old products, and users return them rather than throwing them away. Its legal form, extended producer responsibility, makes manufacturers responsible for collecting and recycling their products. The EU's Waste Electrical and Electronic Equipment Directive, in force since 2003 and revised in 2012, is a large example: producers pay for the collection and recycling of old electrical goods, so the cost of disposal is built into the price of new ones.

Sources: Wikipedia, "Waste Electrical and Electronic Equipment Directive" (read October 2026).

Doughnut economics

Doughnut economics, developed by Kate Raworth, sets a social foundation (enough food, water, health, education and political voice for everyone) and an ecological ceiling (the planetary boundaries). The goal of the economy is to bring everyone above the foundation without breaking through the ceiling, rather than to maximise GDP. Unlike green growth, it addresses inequality and injustice directly, because meeting the social foundation for the poorest is as important as respecting the ceiling.

Researchers have tried to quantify the doughnut for whole countries. A 2018 study by Dan O'Neill and colleagues compared social achievements and resource use in 150 countries and found that not a single country met the basic needs of its citizens at a level of resource use that would be sustainable if every country did the same. Rich countries met social needs but overshot the ceiling; poor countries stayed within it but fell short of the foundation. Cities have also adopted the model, starting with Amsterdam in 2020.

Sources: Wikipedia, "Doughnut (economic model)" (read October 2026); O'Neill et al., _Nature Sustainability (2018)._

Critics argue that the doughnut gives a compelling picture but little concrete policy guidance, and that raising everyone in the world to a comfortable standard of living would require far more output, not less. Supporters reply that the model's strength is changing the goal: once a government measures success by the doughnut instead of GDP, different policies follow.

Case study: Costa Rica’s payments for ecosystem services

Context

Costa Rica is an upper-middle-income country in Central America with an area of about 5.1 million hectares, rich in tropical rainforest, cloud forest and dry forest. In the mid-20th century it lost much of its forest: forest cover fell from about two-thirds of the country in 1940 to a low of roughly 40% in 1987. Most of the cleared land became cattle pasture, as beef exports earned foreign currency and loans from the United States encouraged ranching. In economic terms, standing forest earned its owners nothing, while pasture earned an income.

This was a market failure. The forest provided valuable services (water for towns and hydropower, carbon storage, habitat for wildlife, scenery for a growing tourist industry), but none of them was paid for, so landowners had no reason to keep it. The country's response was to put a price on those services.

What was done

Forestry Law 7575 of 1996 recognised four environmental services provided by forests: mitigation of greenhouse gas emissions, hydrological services (water), protection of biodiversity, and scenic beauty. It created a national fund, FONAFIFO (Fondo Nacional de Financiamiento Forestal), to act as an intermediary between those who benefit from the services and the landowners who provide them. In 1997 the national programme of payments for environmental services (Pago por Servicios Ambientales, PSA) began, the first PES programme run at national scale anywhere.

Landowners sign contracts, usually for several years, to protect existing forest, reforest land or adopt agroforestry, and receive a flat payment per hectare per year; for forest protection this has been about US$64 per hectare. The programme reframed conservation spending as payment for a service delivered, rather than as a subsidy.

How it is funded

• A fuel tax. From 1997, a 3.5% tax on hydrocarbon fuels has paid part of the cost. Fuel users, whose emissions add to climate change, help pay for forests that store carbon: a form of the polluter-pays principle.

• A water tariff. From 2006, holders of water concessions pay a tariff that is spent on protecting forests in the watersheds that supply them: the beneficiary pays. By 2004 FONAFIFO had already signed contracts with 11 companies, such as hydropower and drinking-water firms, to pay for watershed protection.

• International finance. A World Bank loan and a grant from the Global Environment Facility supported the programme from 2001 to 2006, and the Bank renewed its support from 2007 to 2014. In August 2022 Costa Rica received US$16.4 million from the World Bank's Forest Carbon Partnership Facility for cutting emissions by 3.28 million tonnes of CO₂ in 2018 and 2019, the first of three results-based payments worth up to US$60 million for up to 12 million tonnes by the end of 2025.

Data

Historical forest estimates vary with the definition of "forest", so the figures from different sources do not join smoothly, but every source shows the same pattern: steep loss until the late 1980s and steady recovery since. The internationally comparable series from FAO starts in 1990 and shows forest rising throughout the period of the PSA.

Sources: Wikipedia, "Payment for ecosystem services", "Deforestation in Costa Rica" and "Carbon tax" (read October 2026); World Bank, "Costa Rica’s forest conservation pays off" (2022) and press release of 16 August 2022.

Evaluation

The recovery of Costa Rica's forests is real and well documented, and the PSA is widely copied. The question economists ask is how much of the recovery the payments caused. Forest loss had already slowed by the time payments began, and other changes pushed in the same direction: the 1996 law restricted the clearing of forest, cattle ranching became less profitable, protected areas expanded, and ecotourism made forest valuable in its own right. Studies disagree on how much forest the payments saved that would otherwise have been cleared, which is the problem of additionality.

The water tariff has also been criticised for concentrating spending in some watersheds that are not of the highest ecological importance, a reminder that who pays shapes where the money goes. Long-term funding is a further risk: if fuel-tax revenue falls as Costa Rica's transport sector electrifies, the programme will need new sources.

What it shows

Costa Rica shows how environmental economics can correct a market failure: services that were free and therefore ignored were given a price, paid by those who benefit and received by those who protect them. The programme combines several tools from the lens: a green tax on fuel, payments for ecosystem services, valuation of natural capital and international results-based payments of the REDD+ kind.

It also shows the lens's limits: valuation is uncertain, flat payments are not perfectly targeted, additionality is hard to prove, and lasting success has depended on law, protected areas and public values as much as on prices. From an ecological-economics view it is a partial step, keeping natural capital intact within a growth-oriented economy rather than questioning growth itself.

Applying environmental economics across the course

The economics lens is not a separate topic so much as a set of questions that can be asked of any environmental issue. The key questions are who gains and who pays, which costs are external, whether the resource is owned, priced or shared, which values the market ignores, which tool could change behaviour, and whether growth is part of the problem or the solution. These questions apply in every topic of the course.

Topic 1: Foundation

• Natural capital and GDP: standard GDP counts the depletion of natural capital as income, which is why green GDP and environmental accounting were developed; weak sustainability (environmental economics) and strong sustainability (ecological economics) are two answers to whether natural capital can be replaced.

• Environmental justice: externalities rarely fall evenly. Polluting industries and waste sites are more often near poorer communities, so the polluter-pays principle is also a question of justice.

• Sustainable development and the SDGs: several goals assume continued growth (SDG 8, decent work and economic growth), which ecological economists see as in tension with goals on climate and biodiversity.

Topic 2: Ecology

• Human carrying capacity: trade and technology allow a rich country to use far more biocapacity than its own land provides, so its footprint is "imported"; ecological economics measures success by whether footprint is balanced by biocapacity.

• Carbon sinks: forests, peatlands and soils that store carbon provide a service with a real money value once carbon is priced, which is the basis of carbon credits for regenerative farming and forest protection.

• Nitrogen: synthetic fertiliser from the Haber process is cheap because the cost of nitrate pollution in rivers and coastal dead zones is an externality; a fertiliser tax or payments for buffer strips would internalise it.

Topic 3: Biodiversity and conservation

• Option and existence value: most of the value of biodiversity is non-use value (species that might yield medicines, species people want to survive), which markets ignore; this explains why habitats are lost even when people value them.

• Ecotourism: entry fees and tourist spending give living wildlife a use value that can be higher than the value of land converted to farming, but only if the income reaches local communities.

• Conservation costs: protected areas and Key Biodiversity Areas impose opportunity costs on people who lose access to land; compensation and benefit-sharing are economic responses to conservation-driven displacement.

• Rewilding and regeneration: land returned to nature loses farm income, so schemes depend on payments, tourism or carbon and biodiversity credits.

Topic 4: Water

• Water pricing: very cheap or free water encourages waste, but full-cost pricing can make water unaffordable for the poor; many cities use rising block tariffs, in which the first litres are cheap and heavy use costs more.

• Water markets: in the Murray–Darling basin, a cap on total extraction with tradeable water entitlements works like cap and trade for water.

• Fisheries: open-access fisheries are commons; individual transferable quotas give fishers a property right in a share of the catch, and harmful subsidies that pay for extra fishing effort make overfishing worse.

• Pollution: eutrophication imposes external costs on fishing, tourism and drinking-water treatment; sewage charges and fines on polluters apply the polluter-pays principle, and oil companies have paid billions of dollars in fines and compensation after large spills such as Deepwater Horizon (2010).

Topic 5: Land

• True cost of food: food prices leave out soil erosion, water pollution, greenhouse gases and biodiversity loss, so damaging farming looks cheaper than sustainable farming.

• Subsidies: farm subsidies can support either intensification or agri-environment schemes that pay farmers for hedgerows, cover crops and wildflower margins, a form of payment for ecosystem services.

• Land rights: secure property rights for smallholders and Indigenous communities give them a reason to invest in soil conservation; insecure rights encourage short-term use.

• Food waste: halving food waste (SDG 12.3) saves money as well as land, water and emissions.

Topic 6: Atmosphere and climate change

• Carbon taxes, emissions trading and border adjustments: climate change is the largest externality, so carbon pricing is the central economic response; the EU ETS, Sweden's tax and the EU Carbon Border Adjustment Mechanism (from 2026) are tools of the polluter-pays principle; the end of Canada's consumer carbon tax in 2025 shows their political limits.

• Climate justice and finance: high-income countries emitted most historical CO₂, so international climate finance and loss-and-damage funding are debated as polluter-pays at a global scale.

• Ozone: the Montreal Protocol's Multilateral Fund paid developing countries' extra costs of switching away from ozone-depleting substances, an example of rich countries paying for a global public good.

Topic 7: Natural resources

• Value of natural capital: the value of a resource changes with technology and demand (dynamic value), so markets may overexploit a resource while it is valuable and abandon it when it is not.

• Short-term interests: discounting future benefits makes it rational for a firm to harvest a resource now rather than keep it, which explains why maximum sustainable yield is often exceeded.

• Energy: fossil-fuel subsidies keep emissions high, while feed-in tariffs and falling costs have made wind and solar power competitive; fossil-fuel reserves that cannot be burned under climate targets risk becoming "stranded assets".

• Waste: landfill taxes, deposit-return schemes and extended producer responsibility put a price on waste and support the circular economy; exporting waste to poorer countries shifts an externality rather than removing it.

Topic 8: Human populations and urban systems

• Population and consumption: environmental impact depends on consumption per person as well as numbers, so a small, rich population can have a larger footprint than a large, poor one.

• Urban congestion and pollution: congestion charges, such as those in Singapore and London, price road space and reduce traffic and air pollution; low-emission zones charge the most polluting vehicles.

• Air pollution costs: illness and early deaths from urban air pollution are external costs paid in health spending and lost working days, and they fall most on poorer neighbourhoods near roads and industry.

• Green infrastructure: parks, street trees and wetlands have use values (cooling, flood control, health) that can justify their cost in a cost–benefit analysis.

Exam practice

Environmental economics appears in the papers in two ways. It can be the subject of a question in its own right, in Paper 2 Section A or as a Section B essay on, for example, market failure, valuation or degrowth. More often it is the lens that lifts an answer on another topic: the markbands for the final 9-mark part of each Section B essay reward "HL lenses content" in the top band, alongside breadth of knowledge, well-explained examples and a judgement supported by evidence. Paper 1 resources may include prices, costs, taxes or GDP data to interpret.

Using the lens in Section B essays

A strong HL essay does not add a paragraph of economics at the end. It uses economic ideas as part of the argument, in the same sentences as the science and the case studies. The same essay point can be written with and without the lens.

• Market failure and externalities: fits questions on pollution, climate change, eutrophication, air pollution and waste.

• Property rights and the commons: fisheries, forests, groundwater, the atmosphere, the high seas.

• Valuation, use and non-use values, PES: biodiversity, conservation, forests, wetlands, ecosystem services.

• Growth, decoupling, degrowth, doughnut, circular economy: sustainability, energy, resources, urban systems, population.

• Greenwashing: business responses to climate change, consumer choices, certification.

Paper 2 Section A-style questions

Questions that ask for a distinction need both terms defined and a contrast made explicit; an example of each turns a definition into evidence.

Method questions reward the steps in order: who is asked, what they are asked, and how the answers become a value.

Paper 1-style data question

Resource (hypothetical data). A country introduces a carbon tax in 2020 and returns all the revenue to households as an equal payment per person.

Paper 2 Section B-style essay

Summary

• Economics studies how societies produce, distribute and consume goods and services; in a free market, supply and demand set prices that act as signals.

• Environmental economics adjusts markets to account for the environment (technocentric, weak sustainability); ecological economics nests the economy in society and the finite biosphere (more ecocentric, strong sustainability).

• Market failure occurs when markets impose net harm on society; a negative externality such as pollution makes marginal social cost exceed marginal private cost, so too much is produced.

• The polluter-pays principle makes polluters bear these costs through quotas, fines, taxes, tradeable permits and carbon-neutral certification; carbon pricing covered about 28% of global emissions in 2025, mostly at low prices.

• Greenwashing is marketing that makes products look greener than they are; it weakens the market reward for real environmental performance.

• Unclear property rights and unpriced commons lead to the tragedy of the commons; Ostrom showed communities such as Törbel can manage commons sustainably.

• Environmental accounting values natural resources and their depletion; use values may have prices, but non-use values (existence, option, bequest) are estimated by willingness to pay or accept, as after the Exxon Valdez spill.

• Valuing ecosystem services (Costanza et al., the Catskills) and payments for them (Costa Rica's PSA, REDD+, the Amazon Fund) reward conservation but raise questions of additionality, sovereignty and commodification.

• Economic growth is the annual % change in GDP; per capita GDP better reflects living standards but ignores inequality, and growth has both negative and positive environmental effects.

• Relative decoupling is common; absolute decoupling (UK CO₂) is rarer and debated, especially for consumption-based emissions and materials.

• Ecological economists support steady-state, slow or degrowth economies in high-income countries, with footprint balanced by biocapacity; the circular economy (with product stewardship) and the doughnut apply these ideas.

Self-check

• To do:

  I can outline what economics studies and explain how supply and demand set prices.

• To do:

  I can distinguish environmental economics from ecological economics and link each to environmental value systems.

• To do:

  I can draw and annotate a negative externality diagram and explain market failure.

• To do:

  I can evaluate the polluter-pays principle and its tools, with named examples such as carbon taxes and the EU ETS.

• To do:

  I can explain greenwashing with a real example and suggest how to recognise it.

• To do:

  I can explain how unclear property rights lead to the tragedy of the commons, and describe Ostrom's alternative.

• To do:

  I can distinguish use and non-use values and outline how willingness to pay and willingness to accept are measured.

• To do:

  I can evaluate environmental accounting, ecosystem service valuation and payments for ecosystem services, using Costa Rica as a case study.

• To do:

  I can define economic growth and per capita GDP and calculate them from data.

• To do:

  I can distinguish absolute and relative decoupling and interpret GDP and emissions data.

• To do:

  I can discuss degrowth, zero growth, the circular economy and doughnut economics as applications of ecological economics.

• To do:

  I can apply the economics lens to issues from every topic in an extended answer.