Chapter 1 :
When is a Market Socially Optimal?
Basic Definitions
• 1.1 Economic growth and environmental
degradation-Kuznets curves
• 1.2 Welfare economics
• 1.3 Potential Reasons for Gov't Intervention
in the Market
1.1 Economic growth and environmental degradation
Emissions
Resource quality
Income
Figure 1-1 an environmental Kuznets Curves
What does EKCs mean?
Factors affecting emissions:
zAverage rate of growth
zThe technology
zComposition of growth
Implications for environmental policy?
‰ The central recommendations for successful and sustainable development
include formulating the correct macroeconomic policies, creating a
market-friendly orientation, being open to trade, and investing in people
through health and education.
‰Economic growth and environmental sustainability are complex aggregates,
determined by the interplay of numerous factors. Technology and output
composition are important, but these parameters cannot be determined directly.
‰The importance of a good environment for business may be greater than the
availability of finance, because the latter will simply come if the conditions are
appropriate. Of foremost importance for a good business environment appears
to be a transparent, predictable, and reasonable legal and political structure. A
good business environment also requires a reasonable natural environment.
The ideas of EKCs
™The idea behind EKCs is that with economic growth,
emissions typically follow the inverted “U” curve. According
to this hypothesis, the early phases of economic growth
inevitably imply increased pollution, but as incomes increase,
emissions peak and then decline.
™The curve for the quality of ecosystem resources would be
the inverse of that for emission, that is, an upright “U”signifying deterioration followed by gradual improvement.
1.2 Welfare economics
Welfare analysis is a systematic method of evaluating
economic implications of alternative allocations. It
answers the following questions:
1. Is a given resource allocation efficient?
2. Who gains and who loses under various resource
allocations? By how much?
Welfare economics: A methodological approach to assess
resource allocations and establish criteria for government
intervention.
Partial analysis: Evaluates outcomes in a subset of
markets assuming efficiency in others.
Pareto Theorems
The first theorem of Welfare Economics: Pareto optimality is
an efficiency concept that implies that the economic situation
of one individual can be improved only if the economic
situation of another individual is worsened.
The second theorem of Welfare Economics states that any
desirable and feasible outcome of the economy that one
chooses with the help of a social welfare function can be
achieved as the result of a competitive economy.
1.3 Potential Reasons for Gov't
Intervention in the Market
1.
2.
3.
4.
5.
Facilitate information flow
Manage externalities
Provide public goods
Adjust income distribution
Manage non-competitive behavior
1.3.1 Facilitate information flow
Education and extension
Public supported media and information delivery
Collection and distribution of price and other
economic data
Labeling requirements (truth-in-advertising policies)
1.3.2 Manage externalities
Externalities: when activities of one agent affect
preferences/technologies of other agents.
Negative externalities reduce utility or productivity
(pollution).
Positive Externalities increase utility or productivity
(bees and pollinating trees).
Production Externalities: when productivity of an
individual is affected by activities of others (smoke
from a factory affects a nearby "air-dry" laundry).
Consumption Externalities: when welfare of some
individuals is affected by the consumption activities
of other individuals (noise pollution).
1.3.3 Provide public goods
Public Goods are characterized by two features:
1) Nonrivalry: Goods can be consumed
concurrently by more than one individual
2) Nonexcludability: Goods can be accessed
freely
Examples of Public Goods
-Knowledge from education and public research
-National Security
-International Trade Agreements
-Infrastructure, such as roads, bridges, etc.
-Environmental Amenities, such as clean air
1.3.4 Adjust income distribution
Transfer Policies are policies designed to change
the distribution and/or wealth in society.
Examples of transfer policies:
-Income taxes
-Inheritance taxes
-Social Security
-Medicare, Medicaid, and AFDC
-Tax breaks of various kinds to corporations
-Subsidized loans for home buying
1.3.5 Manage non-competitive
behavior
There are many forms of noncompetitive
behavior including the following three forms as
the extremes.
1) Monopoly: One agent controls supply of a good.
2) Monopsony: One agent controls demand for a
good.
3) Middleman: One agent buys the product from the
supplier and sells it to demanders.
Exercise
What does EKCs mean to environmental policies?