Sustainable Economics

slope = m=(y2-y1)/(x2-x1)

price elasticity of demand = % change Q / % change P 

point elasticity of demand = [(Q2 – Q1)/Q1] / [(P2 – P1)/P1] OR slope x P/Q

• Consumer surplus measures the benefit that buyers receive from a good as the buyers themselves perceive it.

• Willingness to pay is the maximum amount that a buyer will pay for a good - is the price lower/higher than how much you value the good 

  • Consumer surplus = willingness to pay – price

• Producer surplus measures economic welfare from the seller’s side.

• Producer surplus = price – costs

• Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society.

• Because the equilibrium outcome is an efficient allocation of resources, the social planner can leave the market outcome as he/she finds it (laissez faire: letting the market go/do as it does)

• drives a wedge between price buyers pay and price sellers receive 
• reduces both, consumer and producer surplus 

E = R where R = P X Q 

• if P increases = E decreases ; or P decreases = E increases then elastic demand |n|>1
• if P increases = E increases; or P decreases = E decreases then inelastic demand 0 < |n| < 1
• If changes in P = E remains constant then unit elastic |n| = 1

• The slope of the budget constraint line equals the relative price of the two goods, that is, the price of one good compared to the price of the other. It measures the rate at which the consumer can trade one good for the other.

• An indifference curve is a curve that shows consumption bundles that give the consumer the same level of satisfaction (= utility)

• MRS: The slope at any point on an indifference curve is the marginal rate of substitution. It is the amount of one good that a consumer requires as compensation to give up one unit of the other good.

Property 1: Higher indifference curves are preferred to lower ones.

• Higher indifference curves represent larger quantities of goods than do lower indifference curves.

Property 2: Indifference curves are downward sloping

• if the quantity of one good decreases, then the quantity of the other must increase

Property 3: Indifference curves do not cross

• consumer's choices are said to be consistent

Property 4: Indifference curves are convex.

• People are more willing to trade away goods that they have in abundance and less willing to trade away goods of which they have little.

• These differences in a consumer’s marginal substitution rates cause his or her indifference curve to be convex. 

• Consumers want to get the combination of goods on the highest possible indifference curve.

• However, the consumer must also end up on or below his budget constraint.

• Consumer optimum occurs at the point where thehighest indifference curve and the budget constraint are tangent.

where, MRS = relative price 

• An increase in income shifts the budget constraint outward = higher Indifference curve / utility bundle 

• If a consumer buys more of a good when his or her income rises, the good is called a normal good.

• If a consumer buys less of a good when his or her income rises, the good is called an inferior good.

• A fall in the price of any good rotates the budget constraint outward and changes the slope of the budget constraint.

• Leads to a new optimum 

• The income effect is the change in consumption that results when a price change moves the consumer to a higher or lower indifference curve 

  • as you may have available income to spend on other goods 

• The substitution effect is the change in consumption that results when a price change moves the consumer along an indifference curve to a point with a different marginal rate of substitution.

1. Change relative prices

• Taxing dirty goods: Substitution effect, negative income effect

• Subsidizing green goods: substitution effect, positive income effects

2. Ban on dirty goods

• substitution effect and income effect lead to maximum consumption of the other good that is still affordable

3. Tax Income

• Strong negative income effect, no substitution effect, i.e., unclear how high green and dirty consumption decreases relatively

4. Change preferences towards greener consumption (e.g. by marketing, campaigning)

• Indifference curves shift, could mean more green consumption and also less consumption in general

• Saturation effects (more consumption does not always increase utility)

• Basic needs (some consumption may not be substitutable)

• Limits to rationality (due to limited information, cognitive biases etc.)

• General concept of utility (how to measure utility, how to integrate goods that are not bought on markets)

• Environmental costs of consumption not reflected in good prices

• Affordability concerns

REMM: Resourceful Evaluating Maximising Man

• A model to explain human behavior, not a normative idea of man (how humans should act)

• Based on Homo Oeconomicus: a person who acts rationally on the basis of available information (utility-maximisation)

1. Bounded Rationality: Limited capacity to process information

• Hindsight bias, framing, etc. 

2. Emotions: decisions are influenced by green/fear/envy

3. Moral Values: normative conceptions about good/bad fair/unfair 

• people do not only derive utility from material goods but also from “fair shares”

• Fairness: we expect our transaction partner to act according to specific norms; departures from these norms can be sanctioned

• Fairness allocation: allocations that are equitable (no envy)

• Price as a mechanism to allocate resources is perceived unfair by many people 

• Altruistic preferences: "warm glow" of being charitable

• Costs of moral/ethical behavior

  • (Opportunity) costs: e.g., behaving environmentally friendly is often more expensive, time consuming

  • Exploitation costs: people who act morally/cooperate may be exploited by others behaving selfishly (e.g., prisoners’ dilemma)

• Costs of unethical behavior: legal/social sanctions

• moral values prevail in low-cost situations / easy to perform tasks (switching off the lights)
• the utility from complying with a norm must make up the difference between the costs ofp pro-environmental behaviour and its alternative 

• A prerequisite for environmental policies are green preferences articulated by the electorate

• Compliance with legal rules for which monitoring and enforcement are incomplete (e.g., waste disposal)

• Absence of legally binding rules (e.g.,global environmental problems)

• An externality refers to the uncompensated impact of one person’s actions on the well-being of a bystander (positive or negative)

• Externalities cause markets to be inefficient, and thus fail to maximize total surplus

• Internalizing an externality involves altering incentives so that people take into account the external effects of their actions

• Social Cost = Marginal Private Costs (MPC) of the producer + Marginal External Costs that are costs to the adversely affected bystanders (MEC)
• Social Cost = MPC + MEC
• When externalities are accounted for, the equilibrium point moves to a new point, called the optimum.

• if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own

• Transaction costs are the costs that parties incur in the process of agreeing to and following through on a bargain

• Laissez Faire Rule: where the factory own the right to the river; Polluter Pays Rule: where the fishermen own the right to the river 

Private - 

• Often the private solution approach fails because transaction costs can be so high that private agreement is not possible (but transaction costs are also a concern in public policy)

Public - 

• Command and Control Policies 
• Market based policies 

Evaluation Criterias

• Ecological Effectiveness: is a set emission target reached?
• Cost-Effectiveness: is the target reached at minimum cost?
• Dynamic Efficiency: are there incentives for environmentally friendly innovation and abatement cost reductions over time? 

2 Kinds of Costs - trade off between them with the objective to minimize total costs 

• Damage Costs: to the environment
• Abatement Costs: more cost technologies; lower production levels 

Command and Control Policies: direct control by setting standards that mandate a certain performance or behaviour

Ecological Effectiveness: Aggregate emission targets can only be achieved if total number of firms (for absolute emission standards) or the total level of output (for relative emission standards) remains constant; 0 emission standards can be achieved. 

Cost-Effectiveness:

• Optimal individual emissions = where levels of MAC are equal for all (it costs the same % amount per unit; burden is equal for all) 
• Aggregate emission levels tend to be politically set due to insufficient information

Dynamic Efficiency: once standards are fulfilled, firms have no incentive for further reductions and technical progress

• Governments use tax to align private incentive with social efficiency
• Pigouvian Tax: enacted to correct the effects of negative externalities

Cost Efficient: uniform tax rates require no knowledge on MAC required, making them easy to implement;

Ecological Effectiveness: efficient tax rate should equal marginal damage. So knowledge about MAC and MD are necessary (usually not the case)

Ecological Effectiveness: Taxes set higher incentives for technological progress than command-and-control approaches

Process

• setting an overall emissions cap
• allocation of permits to emitters
• trade of permits between emitters via market at permit price
• surrender of permits corresponding to actual annual emissions

Cost Efficiency: A firm that can reduce pollution at a low cost may prefer to sell its permit to a firm that can reduce pollution only at a high cost / Cost-effectiveness is achieved by the forces of supply and demand

Ecological Effectiveness: Overall emissions cap ensures that emission target is reached

Dynamic Efficiency: Permits set higher incentives for technological progress than command-and-control approaches

Excludable & Rivalry: Private Goods (clothes / food)

Non-excludable & non-rivalry: public goods (tornado siren / national defense / free education)

Excludable & non-Rivalry: Club Goods (wifi / cable TV)

non-excludable & rivalry: common resources (ecosystems / fish in the ocean / clean air) 

• A free-rider is a person who receives the benefit of a good but avoids paying for it

• Since people cannot be excluded from enjoying the benefits of a public good, individuals may withhold paying for the good hoping that others will pay for it

Solution to free-rider problem

• government pays for public good if the benefit > costs 
• government pays for public good with tax revenue 

Challenges

• absence of prices for resource costs and social benefits
• factors such as value of life, consumer's time, aesthetics or cultural values are hard to assess

Hardin (1968), Tragedy of the Commons: the market cannot allocate resources correecly with unclear property rights / value of resource 

• Common resources tend to be used excessively when individuals are not charged for their usage.

• individual community members have no incentives to reduce their activity, because individually they only contribute to the problem to a small amount

• Avoiding the overuse of the commons can only be achieved by coercion OR collective action

Government can fix market failure by: allocation of property rights / taxes / regulation to restrict access (issuance of licenses)

• Interest/motivation of users 
• Leadership/culture of community
• Information/awareness of consequences
• Size of Group: smaller is easier to organise
• Resource size: too big = hard to measure; too small = small yield
• Autonomy on decisionmaking (without being frequently overruled by a higher level government authority)