Economics and Sustainability

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Economics and Sustainability

• Lisa Morris, Ph.D.
• Assistant Professor
• Muskie School of Public Service

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Teaching Sustainability Through Economics, and
Teaching Economics Through Sustainability

• Use sustainability model as a framework for
  teaching and evaluating neoclassical
  microeconomic theory and its assumptions.
• Use sustainability model as a framework for
  evaluating market-based policy proposals.
• Use economics to evaluate the sustainability
  model and policy proposals that seek to achieve
  sustainability objectives.

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The Limits of Growth China, choking on its own
success.

• New York Times, Aug. 26, 2007 No country in
  history has emerged as a major industrial power
  without creating a legacy of environmental damage
  that can take decades and big dollops of public
  wealth to undo. But just as the speed and scale
  of Chinas rise as an economic power have no
  clear parallel in history, so its pollution
  problem has shattered all precedents.
  Environmental degradation is now so severe..
  Politicallyit is not clear that China can rein
  in its own economic juggernaut. Public health is
  reeling. Pollution has made cancer Chinas
  leading cause of death, the Ministry of Health
  says. Ambient air pollution alone is blamed for
  hundreds of thousands of deaths each year. Nearly
  500 million people lack access to safe drinking
  water.China is choking on its own success

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The Limits of Growth Case of China

• Large population and govt efforts to control
  growth
• Double-digit economic growth rates
• Energy-intensive growth
• heavy industry, urbanization, cars
• Inefficient energy use
• Coal (cheap but dirty)
• relying on less-efficient, but cheaper,
  technology
• heavy traffic and low-grade gasoline

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The Limits of Growth Case of China

• The benefits of growth
• less poverty (at least in the aggregate)
• The costs of growth
• severe air and water pollution
• rising disease and health care costs
• social unrest linked to unequal distribution of
  costs and benefits of rapid growth
• increasing costs of doing business

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The dismal science, sustainability, and
hope-based teaching and learning

• Discuss Success Stories.
• Show how change-making can be fun.
• Remind them that there is still love, chocolate
  and puppies.

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Structure of Course Microeconomics and Policy

• How the market works (at least in theory)
• What the market does relatively well
• What the market does poorly

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How the Market Works (at least in theory)

• Supply and Demand
• Profits are maximized when production level is
  set to where PMC (when PgtMC the firm enjoys
  super non-zero economic profits)
• Utility is maximized when consumers purchase to
  the point where MUP (when MUgtP the consumer
  enjoys CS)
• When PMC and MUP ? MUMC (most
  efficientwell-being is maximized)
• The Price Mechanism
• High prices discourage consumption of scarce
  resources
• Low prices encourage consumption of abundant
  resources
• Shortage (DgtS) the market mechanism pushes P up,
  thereby encouraging more production and less
  consumption
• Surplus (DltS) the market mechanism pushes P
  down, thereby discouraging more production and
  encouraging more consumption
• Perfect Competition
• Eliminates non-zero economic (super) profits
  (PMCAC)
• Encourages innovation (new, efficiency-enhancing
  technologies)

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What the market does relatively well

• The price system automatically coordinates
  millions of interconnected economic activities
  (i.e., little-to-no central planning required).
• Meets consumer demand at minimum cost, at least
  for certain commodities (many durables and some
  services) and thus maximizes well-being (by
  maxing net gain benefits from outputsgtcosts of
  inputs).
• Creates incentives for innovation, investment,
  enterprise and hard work.
• Results in big growth in productivity and per
  capita incomes and increased variety of
  goods/services.

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What the market does poorly

• Business cycle fluctuations
• Distributes income and goods unequally
• Markets fail (monopoly, externalities, moral
  hazard, imperfect information, principal-agent
  problems, rent seeking)
• Cant readily provide public (non-rival
  consumption and non-excludable) goods
• Misallocates of resources between present and
  future
• Market mechanism makes public and personal
  services (health, education) increasingly
  expensive

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Sustainability Model

• Sustainability seeks to balance three things
• Economic growth/development/well-being
• Ecological/environmental protection/preservation
• Socioeconomic equity/equality

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Economics and Sustainability

• Neoclassical (mainstream) Economics
• Under prefect conditions, market forces of S D
  get the prices of inputs and outputs right and
  therefore allocate scarce resources efficiently
  (in such a way as to maximize well-being while
  minimizing costs)
• Even under less-than-perfect conditions, the
  market still scores higher (than government
  intervention, especially regulation) on
  efficiency
• Environmental Economics
• Market failures
• Calculation of the impact of environmental
  degradation and the pricing of environmental
  services
• Determination of efficient levels of pollution
  control
• CBA of pollution solutions and conservation
  efforts
• Market-based solutions to control pollution and
  natural resource depletion
• Ecological (green) Economics
• Efficient allocation of resources
• Scale issues/limits to growth/carrying capacity
  and tipping points
• Growth versus development (improvement in quality
  of life)
• Equity and the distribution of well-being

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Challenging Market Efficiency

• Imperfect Competition
• inefficient use of inputs not punished by market
  forces
• Market Failures
• prices are wrong and so the market cant allocate
  resources efficiently
• Utility maximization assumption
• market efficiency claims start with the
  assumption that consumers are maximizing their
  utility. If they are not, the result is an
  inefficient allocation of society resources.
• Profit maximization assumption
• Some socially responsible firms accept reduced
  profits in order to protect environment

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Imperfect Competition

• Perfect competition is a theoretical ideal and
  very rare in real life.
• Many firms, identical goods, no entry/exit
  barriers, perfect information
• Competition is what forces firms to produce what
  consumers want at least possible cost.
• Imperfect competition ? less than efficient
  allocation of resources.
• Questions
• Can firms bringing new greener products to
  market compete with established, larger firms?
• What are the barriers to getting alternative
  energy sources to market?
• Could their be any advantages to monopoly market
  structures?

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Market Failures

• Negative Externalities
• costs imposed on others outside buyers and
  sellers
• prices not right (true cost private social)
• Producer side (dumping into water, spewing into
  air)
• Consumer side (gas, Hummers, McMansions)
• Certain (Impure) public goods
• rival (depletable) but non-excludable (cant
  prevent free riding)
• tragedy of the commons
• natural resources, clean air, clean water
• Imperfect Information
• science takes longer than the market
• uncertainty and risk
• climate change debate, health effects of
  pollution, current technology (remember when
  plastic was the answer to all things)

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The economics of negative externality

• Definition When a party outside of the economic
  exchange between consumer and producer is
  impacted negatively
• Profit maxing firms set output level so that MCP
  (and utility-maxing consumers make sure MUP).
• But, in this case, MC is not true cost
• True cost MSC MPC to producer external
  costs
• Since MPC lt MSC, the firm produces too much and
  charges too little and so consumers buy too much
  (inefficient allocation).
• Therefore, smaller outputs than those that max
  profits will be better for society.
• Because wherever there are negative externalities
  MUltMSC therefore, society benefits if the output
  produced was smaller because it would lose the MU
  but save the greater MSC.

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Pollution as market failure

• Pollution is a negative externality.
• The failure occurs because a firm or a consumer
  is able to use up some clean air or water without
  paying for the privilege.
• No one has property rights to air, water and so
  these resources are free.
• Because it is costless, firm or consumer uses
  clean air or water wastefully.
• Discussion Efficiency of pollution solutions?
• Direct regulation vs. eco-taxes
• Coase Theorem and Critiques of Coase
• Coase Theorem is useful for analyzing why govt
  interventions sometimes result in the more
  expensive (i.e., less efficient) solution

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Utility Theory and Efficiency

• Basic theory on consumer demand
• Consumers are rational (self-interested utility
  maximizers)
• They spend their in such a way as to minimize
  paid in order to maximize their satisfaction
  (optimal purchasingMUP)
• market efficiency claims start with the
  assumption that consumers are maximizing utility.
  If they are not, the result is an inefficient
  allocation of society resources.
• Discussion
• Rationality assumptions
• Imperfect information on goods/services, quality,
  prices, impacts of their consumption choices
• Imperfect information causes buyers to make
  poor/costly decisions (PgtMU).
• Goods (utility) vs bads (disutility)
• Hummer drivers are they being rational?

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Profit Maximization and Efficiency

• Economic theory on profit maximization
• firms should expand its output as long as the
  added output contributes more to total revenue
  than it does to total cost.
• additions to TR and TC per unit of output are MR
  (marginal revenue) and MC (marginal cost),
  respectively.
• output should optimally be set where MRMC
  (occurs where TR-TCprofit is at a maximum).
• Questions/Discussion
• Why do we assume that firms maximize profits when
  it is easy to find companies that pursue other
  goals such as protecting the environment?
• Does this mean that these firms are producing at
  MCgtMR?
• Using economic analysis, discuss, for example,
  Sillys Portland restaurant)100 percent recycling
  commitment and how it might impact their
  production function and their ability to maximize
  profits.
• Other examples of socially responsible business
  practices?
• Stonyfield farm Yogurt
• United for a Fair Economy

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Efficient Allocation of Resources andthe
optimal level of pollution

• Environmental damage cannot be reduced to zero
• Law of conservation of matter and energy
• Trade-Offs must be made
• Development versus the environment
• Optimal level of pollution control
• In theory, when marginal costs of abatement
  marginal benefits of reduced pollution
• Requires perfect knowledge of physical world and
  perfect wisdom in knowing how to value things,
  both present and future.
• Discussion
• Wealth versus cleaner environment
• Wealth buys material comfort, safety, food,
  education, health care, etc.
• Jobs versus the environment
• Challenges to measuring benefits to abatement
  (avoided costs of negative impacts)
• Imperfect information about the negative impacts
  of pollution
• The new book The World Without Us

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Determinations of Efficiency and Cost Benefit
Analysis

• Usefulness of CBA
• Efficiency, cost effectiveness of policy
  solutions
• Valuation of environmental services (benefits)
  and the costs of their depletion, degradation
• Limitations and challenges to CBA
• Prediction and estimation of impacts
• Getting the prices right for costs and benefits
• Determining the boundaries of the analysis (who
  and what has standing where do you stop counting
  costs and benefits)
• Voorhees, Scott, A. et. al., (2000) An Ex-Post
  Cost-Benefit Analysis of Nitrogen Dioxide Air
  Pollution Control Program in Tokyo Journal of
  Air and Waste Management, Volume 50, Number 3,
  pages 391-410.
• Kelman, Steven (1992) Cost-Benefit Analysis An
  Ethical Critique in The Moral Dimensions of
  Public Policy Choice Beyond the Market Paradigm.
  Pittsburgh, PA University of Pittsburgh Press.

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Tradable Pollution PermitsAssignment

• Readings
• Levy, John M (1995) Chapter 12 Selling the Right
  to Pollute in Essential Microeconomics for
  Public Policy Analysis. Westport, Connecticut
  Praeger.
• Tietenberg, Tom The Tradable-Permits Approach to
  Protecting the Commons Lessons for Climate
  Change by (2003) Oxford Review of Economic
  Policy, Vol 19, No 3.
• Controlling Global Climate The Debate over
  Pollution Trading Report (Winter 1999) from the
  Institute for Philosophy and Public Policy,
  Maryland School of Public Affairs, University of
  Maryland. www.publicpolicy.umd.edu/IPPP/winter99/c
  ontrolling_global_climate.htm
• The Mercury Scandal Paul Krugman, New York
  Times, April 6, 2004
• Questions
• Using economic efficiency analysis, discuss and
  compare the following approaches to pollution
  reduction direct regulation, pollution taxes,
  subsidies, and tradable pollution permits.
• Critics of emissions trading argue that cap and
  trade programs are a license to pollute. Using
  economic theory and principles, evaluate this
  argument.
• While tradable permit programs generally score
  well in terms of efficiency, they do less well
  when it comes to equity concerns. What are the
  distributional (spatial and temporal) issues with
  tradable permits programs versus taxes on
  pollution and direct limits on emissions?
• What are some of the ways to deal with the
  creation of hot spots?
• Under what conditions do tradable permit
  approaches work best (at reducing pollution and
  at lower cost than other policy approaches)?
  Under what conditions might tradable permits not
  be the best policy?

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Limits to GrowthDiscussion Questions

• Are consumption-based economies sustainable?
• Is the problem over-population or
  over-consumption?
• What about Chinas population control efforts?
• Is green consumption sustainable?
• How do markets deal with non-renewable resources?
• How does economics explain over-fishing and
  empty-sea predictions?
• What are the implications of declining oil
  supplies? Are we now starting to run out of oil?
  Is the strategic oil reserve efficient?

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Are consumption-based economies sustainable?

• .our enormously productive economydemands that
  we make consumption a way of life.. (1950,
  market analyst Victor Lebow)
• Discuss
• planned (built-in) obsolescence and short-lived
  products
• What would happen if we all reduced our
  consumption?
• Recession fears, jobs vs environment
• Will green consumption be sustainable?
• Use economics to evaluate
• Live simply so that others may simply live
• Consume less, share more
• Bonos Buy (RED) campaign

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Is the problem over-population or
over-consumption?

• Currently there are 1.7 billion members of the
  consumer class and our environment is suffering.
• What happens if even 50 of the projected 9
  billion global residents enter the consumer
  class?
• Reading assignment State of the World 2004 The
  Consumer Society. The World Watch Institute.

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Top 10 Natl Consumer Class Populations (2002)
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Foot Print Assignment

• Using the carbon calculator and the ecological
  footprint, calculate the impact of your
  consumption choices on the environment.
• http//www.myfootprint.org/
• http//www.nature.org/initiatives/climatechange/ca
  lculator/
• http//sustainability.publicradio.org/consumercons
  equences/
• How do you rank compared to the average American?
  The average global citizen?
• Discuss your consumption patterns. How do you
  make the biggest impact on the environment?
• What kinds of things do you currently do to
  reduce your footprint?
• Discuss the methodology and data used to
  calculate foot prints. Do they seem reliable
  and accurate? Are there items that are not
  included, data that is not collected, that you
  think should be, that might make footprint
  calculations more accurate (be specific, give
  examples)?

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What about Chinas Population Control Efforts?

• The costs of over-population were (and continue
  to be) huge
• Chinas policies (begun in 1970s) have
  successfully reduced pop growth rates (in some
  areas more than others)
• Discussion
• Efficiency vs liberty vs equity
• Social insurance programs
• Sex imbalances

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Reading Assignments(in addition to standard econ
text)

• Garrett Hardins The Tragedy of the Commons
• 4 additional essays responding to Hardins
  original essay, including
• Letters Freedom to Breed
• The Tragedy of the Commons Revisited
• Extensions of the Tragedy of the Commons, and
• Revisiting the Commons Local Lessons, Global
  Challenges
• Crossette, Barbara (Winter 2002/2003) Behind the
  Great Wall Chinas Population Policies,
  Conscience, Volume 23, Number 4.
• Attane, Isabelle (2002) Chinas Family Planning
  Policy An Overview of its Past and Future,
  Studies in Family Planning, Volume 33, Number 1.

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Economic Theory of Natural (Nonrenewable)
Resources

• Scarcity and prices
• A reliable indicator of the availability of
  depletable resources is the price of the
  resource.
• Theory predicts ever increasing prices of
  non-renewable resources
• Exhaustion of most accessible and cheapest
  sources
• Declining overall supply (inward shift of S
  curve)
• Increasing rates of consumption (outward shifting
  D curves)
• The virtues of rising prices
• Discourage consumption and waste.
• Provide an inducement for conservation.
• Stimulate more efficient use by industry, or the
  use of substitute resources.
• Induce technological innovations that use scare
  resource more efficiently.
• Encourage innovation, the discovery of alternate
  resources, and entrepreneurial efforts to get
  alternative resources to market.

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How do markets deal with non-renewable resources?

• Markets and Market Failure
• Impure Public good
• natural resources clean air, clean water, etc.
• rival (depletable) but non-excludable (cant
  prevent free riding)
• Positive externality
• Natural resources can also be analyzed in terms
  of positive externalities
• Environmental services
• Discuss
• tragedy of the commons
• over consumption, depletion (over-fishing, empty
  sea predictions)
• Property rights
• Policy solutions to prevent over-consumption

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Scarcity and Non-Renewable Resources

• Discussion
• Why arent prices for nonrenewable resources
  always increasing (so far anyway)?
• unexpected discoveries of reserves
• new inventions that increase fuel efficiency
• new methods of mining and refining
• govt price controls
• Are we starting to run out of oil?
• What are the implications of declining oil
  supplies?
• Is the strategic oil reserve efficient?
• What are the virtues of rising oil prices?
• Evaluate different policies to get alternative
  fuels to market in terms of efficiency and
  equity.

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Applying Economic Theory to Over-consumption and
the misallocation of resources between now and
future

• Question Are we over-consuming? (destruction of
  irreplaceable resources, negative savings rates,
  too little investment in green alternatives and
  technology, ? conservation, etc.)
• Because prices (interest rates) are wrong
• If investment loans are too expensive ?
  investment in technology for future
• If credit is too cheap (equity lines, credit
  cards) ? over-consume now
• Myopia and immediate need for gratification
• Self-interested individuals utility functions
  dont include the utility of future people
• People dont plan ahead (negative savings rates)
• Consumption therapy and materialism
• Investment has high individual risks
• Imperfect information about future
• Risk discourages investment
• If climate change predictions are right, why
  bother?
• Rational self-interested maximization and
  free-riding
• What difference does it make if I conserve if all
  the other millions of people dont? What
  difference does my little bit of pollution make
  to the aggregate total?

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Growth versus DevelopmentDiscussion Questions

• Does growth always make us better off?
• Why arent citizens of richer countries always
  happier than those of poorer countries?
• What are the limitations to consumption-based
  measures of well-being?
• What are alternatives to consumption-based
  measures of well-being?

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Cost and Benefits of Growth Case of China

• The benefits of growth
• less poverty (at least in the aggregate)
• Improved material well-being (at least for some)
• new goods/services, technology, innovations
• The costs of growth
• severe air and water pollution
• rising disease and health care costs
• social unrest linked to unequal distribution of
  costs and benefits of rapid growth
• increasing costs of doing business
• Discuss benefits and costs of economic
  development in the U.S. context, in Maine, etc.

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Growth (quantitative) versus Development
(qualitative improvements in quality of life)

• Basic theory on well-being
• Consumers are rational utility (well-being)
  maximizers
• Per capita income is indicative of well-being
• More is (generally) better
• Challenges from within Economics
• The declining marginal utility of wealth
• The more you have, the less it adds to your
  overall well-being
• Preference formation and imperfect information
• What if consumers arent really maximizing their
  utility?
• Wealth vs Quality of life
• Alternatives to consumption-based measurements of
  utility (Amartya Sen and Martha Nussabaum)
• Economics of happiness (mixes psychology and
  economics)

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Growth (quantitative) versus Development
(qualitative improvements in quality of life)

• David Cameron, the latest leader of Britain's
  once rather materialistic Conservative Party, has
  espoused the notion of general well-being (GWB)
  as an alternative to the more traditional GDP
  (The Economist, Dec. 19, 2006)
• Net Domestic Product (NDP)
• Adjusted for depreciation of natural capital
• Green GDP
• Includes costs of environmental damage and human
  health
• Human Development Index (HDI)
• Includes qualitative and non-consumption-based
  measures of well-being
• Discuss
• Revealed Preference Theory
• Assumes that actual purchases are accurate
  reflections of the best option and thus of
  maximizing behavior (its a solution to the
  inherent difficulty in directly measuring
  utility).
• Measurement challenges (well-being, estimating
  damage, monetization of impacts)
• Making comparisons with qualitative measures
• The politics when numbers are disputed (Chinas
  green GDP, climate change debate)

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Why arent citizens of richer countries always
happier than those of poorer countries?

• affluenza and capitalism's wasteful materialism
• even Adam Smith had a problem with it. How many
  people ruin themselves by laying out money on
  trinkets of frivolous utility? he complained.
  (The Economist, Dec. 19, 2006)
• declining returns to wealth
• Economic theory predicts that greater wealth
  leads to greater leisure.
• over-consumption ? over-work
• Institutional constraints (labor laws,
  organization of work, etc.)

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Equity and Distribution Discussion Questions

• Are markets fair?
• Is there a zero sum trade-off between efficiency
  and equality?
• If more equality is our goal, what can we do?
• Is there an efficiency argument for green
  technology transfers to developing countries?
• Evaluate Bonos Buy (RED) campaign.
• Discuss the distributional impacts of climate
  change.

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Equity and Distribution

• Distribution of what
• Material well-being
• Costs and benefits of development
• Costs and benefits of the solutions to
  environmental damage
• Distribution among population segments
• rich vs poor
• developed vs less-developed countries
• now vs future
• Discuss
• the differential effects of climate change
• differential capacities to adapt
• Chinas uneven growth and growing inequality
• inequality in U.S. (Katrina)

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Are markets fair?

• The price mechanism rations goods according to
• preferences (willingness to pay the market
  price)
• relative incomes (ability to pay the market
  price)
• Therefore, markets favor the rich.
• Equity fairness
• The market favors those who have wealth (wealth
  begets wealth) and this is unfair
• The market punishes sloth and bad decisions and
  this is fair (merit)
• The market favors the lucky (talented, born into
  rich family, a developed country, at right
  place/right time, etc.) and this is unfair
• Discuss
• equality vs equity
• merit vs luck
• merit vs privilege, oppression, discrimination

42
Economics and the Trade-Off between efficiency
and equity

• Question Is the trade-off between efficiency and
  equality a zero sum game?
• Discuss
• Inequality is efficient it motivates work,
  enterprise, and investment
• The total amount of income in society is not
  independent of how we try to distribute it.
• Policy measures can be enacted to increase
  equality, but usually at a price in terms of
  total output or efficiency.
• In terms of efficiency, there are better and
  worse ways to pursue equality.

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Efficiency vs Equity Trade-offChallenges from
Within Economics

• The elimination of at least more severe
  inequalities will actually raise not lower
  aggregate utility.
• If the following 3 assumptions hold
• declining marginal utility of wealth
• interpersonal comparisons of utility are
  meaningful
• person A will get more utility out of having a
  new pair of shoes than person B will get out of
  having a bowl of ice cream
• people get roughly the same value out of a given
  level of material well-being
• person A would enjoy living the good life about
  as much as B would and that A and B's respective
  experiences of the bad life would be similarly
  comparable.
• Then transfers of wealth (sharing of economic
  pie) will not be inefficient (i.e., result in a
  smaller economic pie).

44
Equality vs Efficiency

• Question If more equality is our goal, what can
  we do?
• Use tax system to redistribute wealth and close
  income gap and let market distribute goods
  according to preference
• Discuss price controls and OPEC oil embargo.
• Why was using price controls less efficient than
  taxes?
• Did the controls help protect the poor from
  rising gas prices?
• Discuss costs to excessive inequality
• social unrest, public health, under-used (human)
  resources

45
Is there an efficiency argument for green
technology transfers to developing countries?

• Negative externalities (air pollution from China
  ? LA)
• Declining marginal returns (if LDC is really
  dirty and it uses green technology it will get
  bigger reduction in pollution for every spent)
• Declining marginal utility of wealth
• Remember, economists measure efficiency in
  overall, aggregate terms
• If the pain wealthy nations feel (in terms of
  lowered consumption) is less than the benefits to
  poor countries, then an efficiency argument can
  be made for the transfer of technology to poor
  countries.
• Question What about assisting low-income
  households in U.S. or Maine become more green?

46
Efficiency and Equity

• The SOTW report said (on page 97) that "rough
  calculations suggest that in order to accommodate
  the twin imperatives of environmental protection
  and social equity, the rich nations may need to
  cut their use of materials by as much as 90
  percent over the next few decades."
• What do you think? Is this feasible?
• What would it be like for you to cut your
  consumption by 25, 50?
• Should developing countries also be required to
  rein in their consumption as part of global
  efforts to reduce pollution and reduce the
  effects of climate change?
• Use economic analysis to evaluate Bonos Buy
  (RED) campaign in terms of efficiency and equity.