ECONS3013
Environmental Economics
Lecture 1: Social Decision Making
Dr Kelly Neill
School of Economics
University of Sydney
July 31, 2023
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Overview
Question:
What is the ‘right’ balance between protecting and using
environmental resources?
1. Positive and Normative Economic Analysis
2. Individual Preferences
3. Social Choice from Individual Preferences
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Reading
• Kolstad Chp 2
(Positive and Normative analysis of Climate Change)
• Kolstad Chp 3
(Social Choice Mechanisms)
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Positive and Normative
Economic Analysis
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Positive and Normative
Positive Economic Analysis:
• describe the world as it is
• free of value-judgements
• relies on logic and data
• often an input into normative analysis
Normative Economic Analysis:
• involves value-judgements
• compare the costs and benefits of public policies
• contribute to policy debate
What should be done? When should we do it?
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Positive and Normative
Statement Pos or Norm?
Coral bleaching will reduce tourist numbers Positive
at the great barrier reef
Coal-fired heating reduced life expectancy in China Positive
The Chinese government should continue Normative
providing coal-fired heating to households
Resources are best allocated by allowing the Normative
market to work freely
When less water is available for irrigation, Positive
the price of water is higher
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Individual Preferences
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Individual’s values
A thing has
• instrumental value from its usefulness to humans
EG: fish for food, forest for wood
• intrinsic value just from existing
EG: a blue whale
All individuals value the environment differently, and put different
emphasis on instrumental and intrinsic value.
Next we attempt to define some common philosophies.
See the textbook. Kolstad: Chapter 3, part II
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Biocentrism
• All living things have intrinsic value
• Biologic world (non-human) is very valuable
Examples:
• EG: “No water should be extracted from the Murray Darling
Basin, to protect the species that live there.”
• EG: The animal rights movement: “we should value the existence
of an animals life in the same way that we value a human’s life”
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Anthropocentrism
• The environment is valuable only to the extent that it provides
material gratification to humans.
Examples:
• EG: “The MDB is only valuable because it provides water for
agriculture and households.”
• EG: “A corroboree frog is not useful to humans, so there is no
reason to protect it.”
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Precautionary Principle
• When considering whether to take an action, we should be
cautious about downsides
• If there might be serious or irreversible damages, we should take
action to prevent these damages
Examples:
• EG: “Extracting water from the river today may exacerbate the
environmental damage from a future drought, so we should not
do it.”
• EG: “We don’t know how drilling for gas will damage the water
supply, so we should not do it.”
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Sustainability
No universally-agreed definition, but examples include:
1. The next generation should be as well-off as the current
generation, and this should continue forever.
2. We should use the environment for human needs only to the
extent that the long-term health of the environment is not
jeopardized.
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Sustainability
Corresponding examples:
1. “Using fossil fuels is not sustainable because it causes climate
change and reduces agricultural productivity. But if agricultural
technology improves yields then it can be sustainable.”
2. “Using fossil fuels is not sustainable because climate change will
ruin the Great Barrier Reef and we cannot replace that.”
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Sustainability
Key question that differentiates views:
• Can we substitute natural capital (eg: resources, ocean, species)
for human-made capital (technology)?
So split into two types of sustainability:
1. Weak sustainability
utility levels do not fall from one generation to the next
2. Strong sustainability
utility levels do not fall from one generation to the next, and
natural capital is not replaced by human-made capital.
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Utility
Which individual is the environmentalist?
Anna’s indifference curves Bill’s indifference curves
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Utility
Which individual is the environmentalist?
Anna’s indifference curves
• Give up certain amount of e,
must compensate with a lot
of c
Bill’s indifference curves
• Give up certain amount of e,
can compensate with a little c
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Utility
Draw three indifference curves for a representative agent choosing
between radioactive waste and air pollution.
Explain the reason for the following features of your indifference
curves:
1. slope (increasing or decreasing?)
2. curvature (flat or steep?)
3. utility level
(which curve has the highest and lowest level of utility?)
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Social Choice from Individual
Preferences
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Social Choice
Utility possibilities
frontier
• Society has fixed resources
• Individuals get utility from
consumption goods and
environmental goods
• But there is a trade off between
− consumption by each individual
− consumption and environmental
goods
• Utility possibility frontier (UPF)
shows all combinations of utility that
are feasible with the fixed resources
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Voting rule 1: Unanimity
Unanimous voting rule:
• Choose bundle Y over X if every individual prefers Y over X
(or is at least indifferent)
• This is the same as requiring a Pareto improvement
Pareto Preferred
The bundle Y is Pareto preferred to X if at least one person has
strictly higher utility under Y than X , and no-one has lower utility.
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Voting rule 1: Unanimity
Utility possibilities
frontier
• Assume we start at X
• A ‘unanimous’ voting rule would
approve Y but not Z.
• Y is Pareto preferred to X
• Z is not Pareto preferred to X
Problems with this voting rule:
• Only need one person to veto a
change
• Bias toward the status quo
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Voting rule 2: Add side-payments
Unanimity with side payments:
• Choose bundle Y over X if the individuals that prefer Y are
willing to compensate the others enough that they also prefer Y
• This is the same as requiring a potential Pareto improvement
Potential Pareto Improvement
The bundle Y is a potential Pareto improvement to X if there is a
transfer zi for every individual so that at least one person has strictly
higher utility under Y than X , and no-one has lower utility.
The winners can compensate the losers by at least enough to
make them indifferent.
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Voting rule 2: Add side-payments
Utility possibilities
frontier
• Z is a potential Pareto improvement
to X if Anna can give Bill enough of
the consumption good to make him
indifferent eg: shifting to Z’
• This voting rule would approve Z.
Problems with this voting rule:
• Compensation payments do not need
to happen. That’s why it’s called a
potential Pareto improvement.
• May be considered inequitable.
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Pareto improvement example
Assume a city of 1,000,000 people, 60% of whom are willing to pay
$1 maximum (each) to clean up pollution. The rest of the population
is wealthier and willing to pay $100 each to clean up pollution.
Pollution clean-up costs $2,000,000. It has been proposed that each
person be taxed equally to pay for the pollution clean-up.
• The impact on the poor from the policy is:
• The impact on the rich from the policy is:
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Pareto improvement example
Is the policy a Pareto improvement?
Is the policy a potential Pareto improvement?
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Other voting rules
• Majority rule - if more than 50% prefer it, then adopt it
• Supermajority - if some fraction (greater than 50%) prefer it,
then adopt it
• More complicated when there are more than two alternatives
The voting rule we choose is a normative decision!
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Social Welfare Function
• Rather than voting, we could measure the group’s preferences
using a Social Welfare Function
• This aggregates individual utility to get a societal utility function
• Choosing how to aggregate is a normative decision
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Social Welfare Functions
Benthamite / Utilitarian: value total utility, but can weight each
person differently with θi ≥ 0
W (U1, ...,UN) =
∑
i
θiUi
Rawlsian: only as well-off as the weakest member
W (U1, ...,UN) = min
i
(Ui )
Egalitarian: value total utility and the distribution. Apply a penalty
for inequality with λ > 0
W (U1, ...,UN) =
∑
i
θiUi − λ
∑
i
[
Ui −min
i
(Ui )
]
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A perfect mechanism is impossible
• All of the choice mechanisms discussed above have a draw-back
or involve a value judgement.
• Is it possible to create a social-choice mechanism that is an ideal
aggregation of individual preferences?
• Kenneth Arrow proved that the answer is no. Not even in theory.
• But we still need to make social decisions.
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Arrow’s impossibility theorem
There is no rule that converts individual preferences into a social
preference ordering and that satisfies the following:
• Completeness. All alternatives can be compared.
• Unanimity. If everyone prefers a to b then society prefers a to b.
• Non-dictatorship. No-one always gets their way.
• Universality. Any possible individual ranking is permissible.
• Transitivity. If a is socially preferred to b, and b is socially
preferred to c, then a should be socially preferred to c.
• Independence of irrelevant alternatives. Society’s choice
between a and b should depend only on how individuals rank a
and b, without regard to other alternatives.
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In this class
As in much of economics, we will take the perspective of a benevolent
dictator. We want to:
• Aggregate individual preferences
• Find the socially-preferred outcome according to our metric -
usually the Pareto Criterion
• Figure out how we can give individuals incentive to achieve that
outcome
Keep an eye out for normative analysis.
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Environmental choices in practice
We use markets
• Markets match producer costs with consumer valuations. For
most goods this yields the “right” amount of it
• For environmental goods (or bads), markets typically do not give
the socially-desirable amount
We use government processes
• Governments can make decisions on behalf of society
• It’s an indirect and imperfect social choice mechanism
We use special interest groups
• Interest groups (NGOs) provide environmental goods (or bads)
• Only represent part of society
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