Case Studies
Externalities and the Environment

Case Study #1: Destruction of the Tropical Rain Forest
Case Study #2: City in the Clouds

Case Study #1
Destruction of the Tropical Rain Forest
[Case Study Questions]

The Rainforest Alliance at is an international nonprofit organization dedicated to the conservation of tropical forests. Its goal is to promote economically viable alternatives to the destruction of this endangered natural resource. Look through this site to find examples of the role economics plays in the projects and research the group supports. The Rainforest Action Network is another group devoted to rainforest conservation but focuses more on citizen activism. Visit its site at and compare and contrast the approaches of these two groups.

The tropical rain forests have been called "the lungs of the world" because they naturally recycle carbon dioxide by transforming it into oxygen and wood, thus helping to maintain the world's atmospheric balance. The Amazon rain forest contains the largest collection of plant and animal life on Earth, along with 20 percent of the world's water supply. But the high world demand for timber has caused loggers to cut down much of the tropical forest. Worse yet, farmers burn down these forests to create farmland and pastures. Burning the world's forests has a triple-barreled effect. The loss of trees reduces the atmosphere's ability to cleanse itself, the burning adds yet more harmful gases to the atmosphere, and the forest subsoil usually contains huge quantities of carbon subject to oxidization when the trees are removed. Since the world's atmosphere is a common pool, the costs of deforestation are imposed on people around the globe.

Forest acreage throughout the world has declined by 15 percent over the last decade. The Amazon has lost 260,000 square miles of rain forest, an area the size of Texas. The north coast of South America contains one of the world's largest unspoiled tropical rain forests, but the governments of Guyana and Suriname have opened huge tracts of forest for logging by companies from Korea, Indonesia, and Malaysia. In Central America, the forests have been cleared for cattle ranches. Commercial logging has been so extensive in the African countries of Ghana and the Ivory Coast that the business is already winding down, leaving behind poverty and devastation. According to the World Bank, two-thirds of the countries that export tropical forest products are running out of trees.

The loss of the tropical forests causes other negative externalities as well. As long as the tropical forest has its canopy of trees, it remains a rich, genetically diverse ecosystem. Tropical forests cover only 6 percent of the Earth's land surface (down from 12 percent 50 years ago), but they contain half of the world's species of plants and animals, and thus represent an abundant source of fruits, crops, and medicines. One-fourth of the prescription drugs used in the United States are derived from tropical plants, such as seeds that may help cure some types of cancer. Biologists estimate that 50,000 species are condemned to extinction each year because of deforestation. Yet most tropical plants have not been tested for their medicinal properties.

Small farmers and wood gatherers and big lumber companies are stripping the tropical forests. Once the forests are cut down, the tropical soil is eroded by rains and baked by the sun and soon runs out of nutrients. When the nutrients are lost, the system is not very resilient. It takes a century for a clear-cut forest to return to its original state. The policy of cutting down everything in sight is of benefit only to loggers, who usually do not own the land and thus have little interest in its future.

The world's rain forests are located in countries that are relatively poor: Brazil, Peru, Indonesia, Zaire, and the Philippines. Environmental quality is a normal good, meaning that as incomes rise, the demand for it increases. In poor countries, however, the priority is not environmental quality but food and shelter. Brazil and other developing countries are destroying their forests to provide jobs. But since the soil quickly loses its nutrients to erosion and the sun, few settlers have become successful farmers.

The tropical rain forests, by serving as the lungs of the world, confer benefits around the globe. But the positive effects that the trees have on the atmosphere tend to be ignored in the decision to clear the land. Worse yet, the taking of timber is often "first come, first served," and government investment programs frequently subsidize the harvesting of timber. It is not the greed of peasants and timber companies that leads to inefficient, or wasteful, uses of resource, but the fact that the atmosphere, and, indeed, the rain forests are open-access resources that can be degraded with little immediate personal cost to those who clear the forests.

What to do? Those who benefit from the tropical rain forest should be willing to pay for the benefits. Government programs that encourage selective cutting and replanting would allow the forest to remain an air filter and a renewable source of forest products. For example, with help from the World Bank and the World Wildlife Fund, Brazil announced plans in 1998 to protect an area of rain forest the size of Colorado. Other ideas are on the drawing board, but a systematic solution is still a long way off.

Sources: Edmund Andrews, "For Europeans, Greenhouse-Gas Issue Is How Much to Cut," New York Times (4 December 1997); "Brazil to Set Aside 62 Million Acres of Forest Lands," Minneapolis Star Tribune (30 April 1998); Thomas C. Schelling, "Some Economics of Global Warming," American Economic Review 82 (March 1992): 1-14; "Argentina Makes Plans to Aid Reduction of Global Warming," Hartford Courant (12 November 1998); and "Saving Rain Forests," San Francisco Examiner (24 April 1998).

Case Study Questions

Why does a solution to the overharvesting of timber in the tropical rain forests require some form of international cooperation? Would this be a sufficient solution to the deforestation problem?


Case Study #2
City in the Clouds

GAIA, a collaborative effort of European research centers and universities, builds multi-media tools for environmental education and management. It presents an interesting case study, "Urban Air Pollution in Mexico City," at
. What are the major sources of air pollutants in Mexico City, and what are their primary effects? What plans are there to control emissions? A photographic essay illustrating the problem is archived by the National Geographic Society at

Mexico City has a metropolitan population of 24 million, ranking it the second-largest city in the world. There are 41,000 people per square mile, about four times the density of New York City. More than half of Mexico's industrial output is produced in or near Mexico City. Millions of vehicles and tens of thousands of small, poorly regulated businesses spew a soup of pollution into the atmosphere. For example, brickmakers fire their kilns with old rubber tires and with sawdust soaked in kerosene-fuels that generate black, acrid smoke. A recent study suggests that leaks from tanks of liquefied gas used widely for cooking and heating are the primary source of smog over the city. In all, an estimated 12,000 tons of pollutants are released into the atmosphere each day.

Pollution problems are compounded by the city's geography and altitude. Mexico City is surrounded on three sides by mountains, so the wind that blows in from the north (the open side) traps pollution over the city. Worse yet, the city's high altitude reduces the oxygen content of the atmosphere by about one-quarter. The combination of high pollution and low oxygen makes for unhealthy air. In the last decade, the number of days when the city's air quality fell below acceptable levels has doubled. Winter smog sends thousands to the city's hospitals with respiratory problems. Some medical specialists claim that living in Mexico City is equivalent to smoking a pack of cigarettes a day. Pollution also contributes to a high infant death rate. Foreign countries advise their diplomats not to have babies while stationed there. Some foreigners who are stationed in Mexico City earn a 10-percent premium as hardship pay.

City officials have taken steps to address the common-pool problem, but their efforts have been halfhearted. The price of gasoline in Mexico City is among the lowest in the world, so price is not much of a check on fuel consumption. Unleaded gas has been introduced but accounts for less than half of the total used. New regulations prohibit half of the city's three million cars from traveling the streets during weekdays, yet fuel consumption has actually increased. And, although stricter regulations have been imposed on business activity, enforcement has been lax.

Part of the problem is that low income levels in Mexico make environmental protection there costly luxury. After adjusting for differences in the cost of living, per capita income there was less than 30 percent of the U.S. level in 1997.

Sources: "Pollution Costs Mexico Millions, Official Says," St. Louis Post-Dispatch (30 May1998); Sam Howe Verhovek, "Pollution Problems Fester South of the Border," New York Times (4 July 1998); "Mexico City Pollution Link to Infant Deaths Is Studied," Chicago Tribune (7 May 1998); and World Development Report: Knowledge for Development 1998/99 (World Bank, Oxford University Press, 1999).

Case Study Questions

Suppose you are the mayor on Mexico City. How can you use some of the techniques outlined in this chapter to control pollution there? (For background information check


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