economics in the biophysical world
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Economics in the Biophysical World. Nicolas Kosoy. Outline. Closed world/open world Circular flow of commodities Value and welfare Externalities Environmental Policy Conclusions. Illimitable cylinder Reinforces the idea of frontiers Beyond known limits. Earth as Planet. - PowerPoint PPT PresentationTRANSCRIPT
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Economics in the Biophysical World
Nicolas Kosoy
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Outline
• Closed world/open world• Circular flow of commodities• Value and welfare• Externalities• Environmental Policy• Conclusions
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• Illimitable cylinder– Reinforces the idea of frontiers– Beyond known limits
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Earth as Planet
• Expanding Universe• Closed system- materials and some energy• Open system –energy (Sun)• Evolutionary perspective• Embedded self
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What about the current economic system?
•Systems may be open or closed in respect to a number of classes of inputs and outputs•World Economy is an open system:• Matter• Energy• Information
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Value and Welfare
• Value: subject-object; subject is human.• Demand: interpretation as marginal benefits,
marginal willingness-to-pay (Derived from utility function - downward sloping=diminishing returns).
• Supply: marginal costs (derived from production function).
• Consumer and producer surplus: marginal versus total benefits/costs (or welfare effect).
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Value- total and marginal WTP
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Partial equilibrium
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Consumer and producer surplus
OBE = sum of producer and consumer surplus
Measure of net social value
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The invisible hand
• Adam Smith 1776: maximisation of individual welfare contributes to maximisation of social welfare.
• Market takes care of an efficient allocation of scarce means: sum of consumer and producer surplus maximal.
• This only holds if social costs = private costs.
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Market failures
• No socially efficient/optimal allocation of scarce means through markets if:
– There are not markets for all goods and services. – There is imperfect competition on some markets.– Economic activities generate externalities– Public goods exist. Property rights are incompletely assigned– Transactions do not occur under perfect information. – Not all firms maximise their profit– Not all individuals maximise their utility (bounded rationality)– There are transaction costs (search, contract, negotiation, policy).
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Negative externalities
• Also known as ‘negative external effects’ or ‘external costs’.
• Social costs = private costs + external costs. => external costs, unlike private (production) costs do not end up in market prices.
• No social welfare optimum: economic activity too large scale, or based on undesirable input mix, or on undesirable production technique.
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Externality
“An externality is present whenever some individual's (say A's) utility or production relationships include real (i.e. non-monetary) variables, whose values are chosen by others without particular attention to the effects on A's welfare.”
Baumol/Oates (1974/1988)
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Externality (cont)
• Unintended effect (originator unconscious): pestering and charity do not generate externalities.
• Externality is technological or physical: direct, physical interaction between humans, not humans and environment - environment implicit.
• Different from monetary (pecuniary) externality: change in demand (taste, fashion) or supply (technology, discovery of resource) affects prices (of products and production factors) and in turn welfare/profit of buyers, suppliers, workers, etc.
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Different externalities
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Technological externalities
• Positive/negative (Marshall/Pigou). • Caused by / effect on: production (profits) or
consumption (utility/welfare).• Symmetrical/asymmetrical (polluter, victim):
congestion vs. river up-/downstream pollution.• Static/dynamic: future, delayed effects;
flow/stock (climate change).• Private/public good (‘bad’)
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Private and Public goods (cont)
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Economic differences
• Private good: marginal willingness-to-pay (WTP, or price) equal for all individuals (single price); different amounts consumed.
• Public good: equal consumption; different WTP (unpaid ‘prices’); total price is sum of individual prices (willingness to pay).
• ‘Free rider’ problem: real WTP cannot be elicited or with uncertainty (purpose monetary valuation methods).
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Optimality vs elimination of externality
• Externalities are no exception or rarity: thermodynamics, scarce space.
• From a welfare perspective the level of external costs should be optimal: derived from the notion of optimal social welfare.
• Thus in general external effects do not need to be reduced to zero: for this would in most cases imply elimination of economic activity (and even human existence).
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Optimality approach
NB(E)=B(E)-D(E)NB: net benefits of pollution;E: flow pollution (emission of a substance);B: benefits of pollution; D: damage costs of pollution.
maximise NB(E): dNB/dE = 0 => dB/dE = dD/dEInterpretation: marginal benefits of pollution should be equal to marginal damage costs.
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Graphical solution
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Environmental policy?• Internalisation (literally !)
– Integration of polluter and pollutee/ victim (merger or take-over) => external costs become private costs.
• Negotation (not same as market !)– Coase(1960): negotations between polluter and victim.
• Regulation (government intervention/policy – Include smarket based instruments – Pigou(1938): regulating with optimal levy.
• Note: Libertarians emphasize social cost of governance itself. Their suggestion of ‘minimal governance’ seems based on perception of local communities, local problems and evolving, self-organised solutions (i.e. lack of global commons and concentrated power). Coase theorem (property rights + negotiation) fits in this line of thinking.
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Coase Theorem
• Conflict solution based on negotiations between polluter and victim.
• Required: enforceable property or user right.• Results:– Allocation satisfies socially optimal level of external
costs => no env. regulation needed.– Efficiency independent of allocation of right: but
there is a distribution effect.– Government has to garantuee rights: legislation,
accessible administration of justice.
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An example
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What is the solution?
1. Right with saxophone player => Ψ3: benefits minus costs = (a+b+d)-(b+c+d) = a- c.2. Right with neighbour => Ψ1: benefits minus costs = 0.3. After negotiations, irrespective of whether one starts from situation 1 or 2, Ψ2 will be the equilibrium outcome3 is optimal: marginal costs= marg. benefits.
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Limitations
• Not realistic in case of many agents: transaction costs high.
• If public good/bad: risk of ‘free rider’ behaviour.• Free entry: influenced by compensation victim(s).• Does not work in case of effect far ahead in the future:
e.g., climate change.• Property rights may influence valuation of costs and
benefits: endowment/status quo effect.• Conclusion: many reasons for government
intervention => Environmental policy theory
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Conclusions• Negative externality central concept in welfare (environmental)
economics.• Many types :static/dynamic, public/private goods
– relevant distinctions for regulation.• In general optimal, not zero level of externality.• Optimality in economics: marginal costs = marginal benefits
– in market, negotiation or regulatory contexts.• Social costs = private + external costs.• Social welfare optimum: marginal social costs = marginal social
benefits.• Coase theorem: surprising insight, but not wide applicability.