Transcript Slide 1

Economic Efficiencey
and
Environmental Protection
Engraving by J. Nash
after sketches by Mr.
Stephens, the mate of
the Mignonette.
(Rischgitz/Getty Images)
Lifeboat of the English yacht Mignonette (1884)
Social Choice
Question 1: How should society decide on which
outcomes (i.e. “allocations”) are “good”?
Question 2: If the criteria is efficiency, how do we
identify the ideal choice or action?
Social Choice
Question 1: How should society decide on which
outcomes (i.e. “allocations”) are “good”?
• By what criteria or value system(s) should we
rank a set of options?
• One criteria favored by economists is the
welfare-oriented notion of efficiency
– maximizing net benefits (Kaldor-Hicks efficiency)
– Caveat: other criteria recognized as important (e.g.
equity)
Ethics: the systematic study of morality (code of
conduct establishing what is right vs wrong)
• Immanuel Kant
– Major work on ethics: Groundwork of the Metaphysics
of Morals, (1785, p. 96):
– Imperative: a proposition declaring a certain
action to be necessary; a motivation for an action
– A hypothetical imperative “presents the practical
necessity of a possible action as a means of
achieving something else which one desires…”
• `means to an end’
– “The categorical imperative would be one which
presented an action as of itself objectively
necessary, without regard to any other end.” Prussian philosopher
• ‘an end unto itself’
Reference: Hackett, 2006
Immanuel Kant
(1724-1804)
Source: wikimedia commons
Value/ethical systems
• deontological ethics
– An action is judged by its intrinsic rightness based on
a moral obligation or duty (not by the degree to which
it serves instrumental goals or aspirations)
– Leads to “categorical imperatives” that prescribe
choice. Examples:
• Kant: “Act only according to the maxim by which you can at the
same time will that it should become a universal law.”
• John Rawls: a system of justice should be determined under a “veil
of ignorance” in which one is not yet aware of one’s status or
position.
• Leopold: humans have no right to reduce biodiversity except to
meet vital needs (land ethic)
• Biocentrism: All species have inherent value irrespective of use to humans.
– Challenge: in a diverse society how do we aggregate
over the moral positions of large numbers of people?
Reference: Hackett, 2006
Value systems, cont’d
• teleological ethics (consequentialism)
– The worth of an action is determined by the
degree to which it has instrumental value in
meeting a desirable goal.
– advocates: Aristotle, Jeremy Bentham (utility),
John Stuart Mill (happiness)
– Examples: prescribes following a social rule
if…
• Egalitarian ethics: equity is enhanced
• Utilitarian ethics: the net change in utility is positive
Reference: Hackett, 2006
Intrinsic morality v. consequentialism
(deontological v. teleological ethics)
• Nativeness: not necessarily positive (e.g. native North American
mountain pine beetle.)
introduced species (left to right) tamarisks, pheasants, honeysuckle and zebra mussels
K. MOLONEY/THE NEW YORK TIMES/REDUX/EYEVINE; T. & P. LEESON/ARDEA.COM; P. DEL TREDICI; J. WEST/PHOTOLIBRARY
Value systems:
Utilitarian ethics
• Jeremy Bentham (1748-1832):
founded doctrine of utilitarianism.
– English moral philosopher, legal
reformer
– Pain and pleasure can be distilled to
a single (+/-) number for each
individual
– Net social utility can be determined
by adding up individual utility.
• Objections:
– individual rights
– validity of common currency
photo: Reeve
References: Hackett (2006; 2011), Sandel (2010)
Value systems:
Utilitarian ethics
• John Stuart Mill (1806-1873):
– Maximize utility in the long run.
Upholding individual liberty will
promote long-run welfare
– “there needs protection” against
the “tyranny of the majority”
Photograph: London Stereoscopic Company/Getty Images
References: Hackett (2006; 2011), Sandel (2010)
Value systems, cont’d
• fundamental elements of utilitarianism (Sen, 1987):
– Consequentialism: “(T)he ethical policy is the one that generates
policy outcomes (“end”) that lead to the largest net social utility.”
– Sum ranking: “The utility information regarding any proposed
rule is assessed by looking only at the sum total of all the
individual utilities associated with the rule.”
– Welfarism: “(T)he goodness of a proposed rule is determined by
the utility or disutility that it creates among members of society.
• Motivates a focus on “efficiency”
• W. H. Auden (1962): “Pleasure is by no means an
infallible critical guide but it is the least fallible.”
References: Hackett, 2006; Amartya Sen (1987). On Ethics and Economics. New York: Basil Blackwell.
Efficiency
• Kaldor-Hicks efficiency: an allocation in which the
aggregate net benefits are maximized
– in which there may be winners and losers, relative to the status
quo (or other comparison point), but where winners could, in
theory, compensate losers for their losses such that no one
worse off than the comparison point.
• Pareto efficiency: an allocation in which no one can be
made better off without making some else worse off.
Pareto frontier
Matt’s
utility
F
B
feasible allocations
C
A
E
D
Mike’s utility
•
•
•
Allocations on the frontier are ‘Pareto efficient’
‘Pareto improvement’: from an initial allocation X, an alternative allocation Y is a Pareto
improvement if at least one person is better off no one is worse off.
Exercises:
1. Allocation ______ is a Pareto improvement relative to ______
2. F and D __[are, aren’t]__ Pareto improvements relative to E
3. The Pareto criteria ____[does | doesn’t]____ provide guidance for choice between D and F
4. How tractable is strict application of the Pareto criterion for real world policy questions (e.g.
climate policy, biodiversity conservation, etc)?
Example: K-H vs Pareto
improvements
Net
benefits
to Mike
Net
benefits to
Matt
K-H
improvement?
Pareto
improvement?
Status quo
100
100
.
.
Alternative A
75
75
No
No
Alternative B
75
200
Yes
No
Alternative C
100
200
Yes
Yes
Alternative D
150
150
Yes
Yes
Policy
h/t Richard Woodward, AMU
Efficiency
•
A policy is (K-H) efficient if it achieves the greatest possible net benefits.
o Net benefits = total benefits – total costs
o NB = TB – TC
•
Efficient choice means maximizing the size of the pie (net benefits)….
is preferred to
>
Note that the K-H efficiency criteria doesn’t
say anything about how the pie is sliced up
(distribution).
Key problem: How do we quantify
the pie/net benefits?
…with a model…
On models in general
• “Essentially, all models are wrong,
but some are useful” (George E. P.
Box)
• "Theories should be as simple as
possible, but no simpler.” (Albert
Einstein paraphrased)
• Models are as good as the underlying
assumptions (garbage in, garbage out)
• Know the purpose and limitations of the model.
A typical model for characterizing benefits
• A model of the benefits to a group or
individual of some good.
• Characteristics typically assumed
(but which are NOT universal)
– Diminishing marginal benefits
– Smooth curves
•
Terminology:
– “Demand”
– “Marginal Willingness to Pay”
(MWTP)
– “Marginal Benefit” (MB)
•
Quantity demanded
Semantic point: when price falls does
demand fall? Not exactly. The ‘quantity
demanded’ falls.
Getting a feel for
marginal benefits vs. total benefits
Definitions
• MB, Marginal benefits (or MWTP): the
(maximum) willingness to pay for a one
unit increase in quantity of a good
– the rate of change (slope) of the total benefit
curve: dTB(x)/dx
• TB, Total benefits (or total WTP): the total
(maximum) willingness to pay for some
quantity of a good.
– Typically the area under the MB curve up to a
given quantity demanded.
WTP approach to characterizing value:
Advantages & Drawbacks
•
Advantages:
–
–
•
renders value observable -- we’re all used to
thinking about currency, we know what a dollar
means
treats individuals as the legitimate source of
judgment as to the value of things.
Drawbacks:
–
–
–
difficulty of measurement
doesn’t account for differences in wealth between
individuals (WTP is also limited by ability to pay).
cannot work well if consumers do not know
potential outcomes with reasonable accuracy
A typical model of costs
• Characteristics typically assumed
(but which are not universal)
– INCREASING marginal costs
– Smooth curves
•
terminology
– “Supply”
– “Marginal willingness to accept”
(MWTA)
Costs of “supplying” the
California Condor
Expected condors saved per year
From the USFW Recovery Plan summarized in Keohane and Olmstead, Markets and the Environment, 2007.
Definitions
• MC, Marginal cost: the change in total cost
when the quantity is increased or
decreased by a unit
– the rate of change (slope) of total cost curve:
dTC(x)/dx
• TC, Total costs: the total cost of supplying
some number of units of a good.
• Typically the area under the MC curve up to a given
quantity demanded.
Definitions: “net”
• Marginal net benefits: MNB = MB - MC
• Total net benefits: NB = TB – TC
• Closely related concept: “surplus”
– Surplus: the total net benefits of producing
and consuming X number of units of a good.
Social Choice
Question 2: If the criteria is efficiency, how
do we identify the ideal choice or action?
• E.g. how much environmental protection
should society choose?
• Need: analytical tools to predict the
impacts of policies on “welfare” (net
benefits).
Putting it all together: identifying the efficient choice
max{X} NB(X)
NB(X)
max{X} TB(X) – TC(X)
Note: TB’(X) = MB(X)
TC’(X) = MC(X)
(calculus) first
order condition for
max: MB(X*) – MC(X*) = 0
suppressing X: MB = MC
One example of the
“equimarginal rule” for
identifying the efficient allocation.
Equating values at “the margin”
• In this case, MB=MC.
Keohane and Olmstead, Fig 2.6
(Note: In other cases the equimarginal
rule might imply a choice where MBA
=MBB or MCA =MCB. )
Putting it all together: identifying the efficient choice
Class exercise:
• Using both
1. definitions in this lecture
(MB, TB, MC, TC,
surplus), and
2. plain language
verbally explain why:
• The point XL is not efficient
• The point XH is not efficient
Social choice from individual
values
• The value that an individual places on goods (e.g. environmental
protection) can be captured (imperfectly) by her demand or
MWTP.
• To assess policies from an economic perspective we will
aggregate the value that society places on goods (or
bads).
• Social welfare: “aggregate” NB (net benefits)
– Several ways to aggregate individual values (e.g. the minimum of
individuals’ NB; weighting NB by income before summing).
– For simplicity in this course we’ll stick with equal weighting
Finding aggregate MWTP for a private good
?
• Aggregate MWTP for a private good:
– Heuristic: “sum demand curves HORIZONTALLY for a private good”
– for any given dollar value (p) sum up the quantity demanded (q) across all
individuals:
qAgg(p) = qA(p) + qB(p) + qC(p)
Classroom exercise:
Calculate aggregate
qAgg(15) = qA(15) + qB(15) + qC(15) = 4+0+3 = 7
quantity demanded at
p = 8.
The need for careful marginal thinking
“The value of the world's ecosystem services and natural capital”
Costanza et al., Nature, May 1997, pp. 253-260.
• “We have estimated the current economic value of 17 ecosystem
services for 16 biomes, based on published studies and a few original
calculations.” (abstract)
• Ecosystem services (a couple examples)
SERVICE
– Pollination:
for plant
reproduction
FUNCTION
Movement of floral gametes
EXAMPLE
 Prov. of pollinators
– Water regulation: Regulation of hydrological flows  Prov. of water for
agric., industry
& travel
• “For the entire biosphere, the value (most of which is outside the
market) is estimated to be in the range of US$16-54 trillion (1012) per
year, with an average of US$33 trillion per year.” (abstract)
– Global GNP ~$18 trillion/yr
Careful marginal thinking…
• Valuation: what is the value of pollination services?
– Method used:
(1) Find the value of pollination for the last marginal hectare pollinated.
(2) Multiply this figure by the total area of land under pollination.
– What does this approach assume about the marginal value of the
particular service as the level declines from current to zero? Is this
reasonable?
• “Because of the nature of the uncertainties, this ($16-54 trillion) must
be considered a minimum estimate.” (abstract)
Further references
Efficiency
“Generally refers to the condition of producing something of value with a
minimum of waste.
• Efficient resource allocation is realized under market exchange with all
the available gains from trade are realized, while …
• efficient production occurs when goods or services are produced at
minimum cost.
• A proposed social policy is Pareto-efficient when it makes some people
better off and nobody worse off in comparison to the status quo or
some other policy option.
• In contrast, a proposed social policy is potentially Pareto-efficient (or
Kaldor-Hicks-efficient) when it generates an increase in total net social
benefits compared to the status quo and other policy options, and thus
the potential exists for those made better off to compensate those
made worse off.”
(Hackett, 2006, p. 490)