Econ Test 3
Consisting of three pillars, sustainable development seeks to achieve, in a balanced manner,
- economic development - social development - environmental protection
Sensitivity Analysis
It is recommended to use a range of discount rates instead of just one value to see how sensitive the NPV of a project is changing due to the different values of discount rates. If NPV stays positive over a reasonable range of rates, we can safely conclude that the benefits outweigh the costs generally and consistently.
*Transboundary pollution*
The *challenge* to sustainable development also includes transboundary pollution issues. Global environmental problems, such as climate change, ozone depletion, oil spill in ocean, and surface water pollution are transboundary.
1. Annuity
Use the second part which is real annuity and plug in the single parameters, first one is the sum of all the years
Sustainable development:
is the development that meets the needs of the present generation without compromising the ability of future generations to meet their needs.
Social discounting rate
Environmental policy development compares the social benefits with the social costs; the discount rate should reflect the social opportunity cost of funds allocated to the provision of public good.
Inflation adjustment:
accounts for the changes in the general price level (purchasing power)
Time value adjustment:
accounts for the opportunity cost of money
Inventory analysis:
identifies and quantifies resource usage and environmental releases.
Inflation correction
is the adjustments for the inflation.
Innovation is not just technological changes. It can take various forms:
productivity (worker's education) product's design how it is produced and marketed consumer's education
(HAVEN EFFECT) Firms face a *competitive disadvantage* when
when face stringent environmental regulation.
*Weak Utility Sustainability*
• Only Utility is sustained.The quantity of environmental goods E can decrease over time.
Public projects (on public goods)
• Projects such as providing public goods, environmental protection or reduce pollution. • Seek for gain in social net benefits, but not necessarily profits. • Market interest rate is not appropriate.
Converting a nominal value to its real value is known as a
deflating procedure.
Goal definition and scoping:
describes the product or process to be assessed, the context for assessment, and environmental effects to be assessed.
Impact analysis:
determines human, ecological effects based on inventory analysis.
Interpretation:
evaluates results and selects the preferred product or process.
Kalundborg Symbiosis
everything in nature has output and inputs so firms that can use output waste from other firms than that a good contributation to the enviromental quality
Sustainable Utility
Assume a representative consumer Her utility at time t depends on two types of goods • Marketable "*Consumption*" goods C • Non-marketable "*Environmental*" goods E
Dynamic efficiency,
with the consideration of *intergenerational equity*, is an example of moving towards the sustainability objective. Sustainability needs to be defined in measurable terms in economics.
P2 Legislation
• *Pollution Prevention Act of 1990* • "Pollution should be prevented or reduced at the source, whenever feasible". • "Manage of residuals through recycling treatment disposal, in that order. - If cannot be prevented, then should be recycled in an environmentally safe manner. - If cannot be prevented or recycled, then should be treated in an environmentally safe manner. - If disposal is the only option, then should be conducted in an environmentally safe manner. • This order hierarchy is summarized as a upside down triangle.
Indifference Curves
• A curve representing all *bundles* that provide a consumer with the same level of satisfaction *(utility)*. • All the *points* along the curve *are combinations* of the *two goods* that make the consumer *equally* happy. • *You can plot as many curves as you like!* • Do you prefer V or U? -points on the same curves make the person equally happy C has higher utitlity level preffered by rational consumers Points U and V: you can add on curves
Does Environmental quality improvement (Regulation) hurt Economic prosperity?
• A survey shows that pollution abatement costs is estimated at about 0.05% of GDP.*
Benefit Cost Analysis (BCA)
• An *analytical tool* used extensively in environmental policy development. • Measure of the efficiency of an environmental policy, program, or project. • Compare the adjusted benefits and costs and make decisions. Has two steps: 1. Determine the feasibility 2. Select among alternative feasible projects
*Strong Utility Sustainability*
• Both Utility and the Quantity of environmental goods E must be sustained, i.e., can not decrease over time
*Sustainable Approaches*
• Common criticism *on the Sustainable development* objective is that it is not a good notion to guide policy. - Vague and ambitious - Difficult to implement meaningfully on exhaustible natural resources such as fossil fuels.
Utility and Indifference Curves
• Downward sloping • Higher curvehigher utility value • Do not cross • Normally shaped like crescent moon (bowed inwards) If At represents the current utility level, Can you find any sustained utility based on moving from At?
Utility
• Economists use 'Utility' to measure the 'usefulness' of goods consumed by consumers. • Utility: the ability of 'economic goods' to satisfy needs or wants. • Represents a quantitative measurement of the 'satisfaction' or 'preferences' experienced by consumers. • Plot "Utility" with the indifference curves.
Remember the Dynamic efficiency rule:
(MSB-MSC)1 = PV of (MSB-MSC)2
This makes us think about the trade-off between
*Economic Prosperity and Environmental Quality*
This is one type of externality -
*International Externality* • A spillover effect associated with production or consumption that extends to a third party in another nation. • How to internalize this externality?
A need to redefine the environmental objective!
*Sustainable development*
1. Extended Product Responsibility (Product Stewardship)
- A commitment by all participants in the product chain— designers, manufacturers, distributors, consumers, recyclers, remanufacturers, and disposers. All are responsible for the environmental effects of a product.
United States - Canada Air Quality Agreement
- Aimed at combating acid rain and visibility impairment - Implemented the *Acid Rain* Annex to set emissions caps on sulfur dioxide and nitrogen oxides - Agreed to the *Ozone* Annex, committing to reducing transboundary ozone-forming pollutants - Negotiations for a *Particulate Matter reduction*
Present value determination
- Benefits and costs do not accrue to society at the same time; - Benefits and costs often accrue at different multiple time periods.
P2 promotes risk reduction by *eliminating or minimizing* wastes, while industrial ecology uses wastes as inputs
- P2 solutions are aimed at a single firm, while industrial ecology is used by a network of businesses. - For example: *Recycling is not* considered as a typical preventive solution, but recycling essentially is a solution in industrial ecology. P2 generally requires government oversight, while industrial ecology tend no to mention government intervention.
2. Design for the Environment (DfE)
- Promotes the use of environmental considerations along with cost and performance in product design and development.
Compounding
-if you deposit $200 in a saving account today; -The $200 is the Principal. You will get an interest payment. -What will be the outstanding balance (the future value) a year later if the annual interest rate is 5%? $200 (1+5%)^1 = $210 If you save more than one year, the compounding formula Time value of Money Time value of money : • Today's $1 is worthy more than Tomorrow's $1. People prefer to receive benefits sooner than later . • Money received now can be invested. • The later a benefit comes, the greater uncertainty of the likelihood of enjoying the benefit. Present value determination • The discounting! you should use is
About the relationship between Economic Prosperity and Environmental quality, there are *two hypothesis*
1. *Pollution Haven Hypothesis* (page 495) 2. *Porter Hypothesis* (not in our textbook)
Four Properties of Indifference Curves
1. Higher indifference curves are preferred to lower ones. (I2> I1 > I0 ) Higher curve indicates higher utility. 2. Indifference curves are downward-sloping. 3. Indifference curves cannot cross 4. Indifference curves are bowed inwards (convex to the origin). Point C will always make you happier *cannot be upward slopping*
The social discount rates used in some government agencies:
1. Office of Management and Budget: 7% 2. Congressional Budget Office: 2% 3. Forest Service Department: 4% 4. EPA: 3% to 7%
If the allocation is to treat the two periods exactly the same
10 miles -10 miles allocation has a higher net benefits than 15 miles -5 miles allocation. Is 10-10 the most efficient allocation?
Cyclical or Closed Materials Flow
A Cyclical or Closed flow model assume the materials run in cycles. - Product design, manufacturing processes, energy use can be modified to achieve a cyclical flow to reduce environmental impacts. - Residuals can be brought back into production. - Policy can aim anywhere in the cycle of production and consumption rather than only at *"end-of-pipe".* - So-called *"Cradle-to-cradle"* flow
Real value
A magnitude adjusted for the effects of inflation.
Nominal value
A magnitude stated in terms of the current period
Environmental Kuznets Curve (EKC)
A positively related or negatively related correlation? • Economists use EKC to model the relationship between *economic growth* and *environmental degradation* as a inverted U-shaped curve. 1. In early stage of industrialization, pollution increases with economic growth. 2. Eventually, more advanced development country will prefer natural resources protection and environmental control and can afford more stringent environmental regulations. Pollution decreases with economic growth.
*Sustainability on a global scale*
Advanced sustainable approaches and technologies are often initiated in developed countries and hence need to be communicated globally, especially to developing countries.
*Green Accounts* considers the depreciation of natural resources, the damage of environmental quality, and look directly at measures of social welfare.
After the Green Accounting adjustments, people or nations are probably not getting rich nearly as fast as they might think.
Plot the MSB and MSC in both periods
By preserving 15 miles the Net Benefit is maximized in each period. If totally 30 or more miles of river are available for allocating, then we have no problem. People in period 1 is happy and people in period 2 is happy too. When the environmental quality is not a scarce resources, allocation is not a concern. However, what if there are only 20 miles of river available? • Should period 1 get more miles or should period 2 get more miles?
*Pollution Haven Effect:*
Changes in international trade that are caused by the cost differences among nations due to varying environmental regulations.
Life Cycle Assessment (LCA) Comprises 4 components
Goal definition and scoping: Inventory analysis: Impact analysis: Interpretation:
• If National Accounts are adjusted to include environmental quality and other missing non marketable goods that affect the social well-being, then we have the
Green Accounting*
Example 3: when interest rate changes
Home Energy Saver website provides ways of conserving energy for homeowners. Based on the statistics, a new home renovation on average will initially cost $4,047, but it will save roughly $744 on heating every year. If you are the homeowner, will you spend the $4,047?
*Linear or Open Materials Flow*
Linear or Open Materials Flow A Linear or Open flow model assume the materials run in one direction. - Enter economic system as inputs, - Leave as residuals and return to the environment, - Policy aim at the abatement at the "end of the pipe". So-called "Cradle to grave" flow
Example 2: multiple cash flows
If there are multiple benefits in different periods, and/or if there are multiple costs in different periods, • discount all the future benefit values, add them up, get the Present Value of all benefits: PV(B) • discount all the future cost values, add them up, get the Present Value of all costs: PV(C) • OR subtract cost from benefit in each period, then discount all the Net Benefits into present value. Ex: In the next five years, there are generated benefits and costs in each year. Assume discount rate is 6%. Find the Net Present Value.
*Industrial ecology*
Industrial ecology is a multidisciplinary systems approach to the flow of energy and materials between production and the environment. The entire life cycle of a product, including all materials and energy flows, ought to be considered in efforts to improve the environmental quality. Some argue that *industrial ecology* is the *means* by which a society promotes *sustainable development*
BCA in practice The difficulties:
Need judgmental calls in the practice. • Confront distributional issues: tradeoff between efficiency and equality • Different discount rate can lead to very different conclusions. • Future benefits/costs involve great uncertainty. • Data may be incomplete, inaccurate, or unavailable.
*Porter hypothesis*
On the contrary, Porter hypothesis assumes the stringent environmental regulation actually triggers technological *innovation*. • Firm will discover cleaner technologies and make environment related innovations. • Firm will design production processes more efficiently. Firms face a *competitive disadvantage* when face stringent environmental regulation.
*International agreement*
One solution to international externality is the international agreement to control transboundary pollution.
BCR's importance With a budget constraint on multiple projects:
Rank projects by ratio: Bi / Ci. Choose highest rank till money is gone. This gets most the benefits for each dollar spent. BCRs becomes important and necessary when NPVs from multiple projects are the same. NPVs becomes important and necessary when BCRs from multiple projects are the same.
Understand EKC: Does this imply that a country can grow its way out of environmental problems as long as the economy keeps growing naturally?
Rather than confirming any pattern, EKC indicates the possibility that the economic prosperity and the environmental improvement can be reinforcing rather than competing objectives.
Different discounting rates
The magnitude of the discount rate could affect the net present value significantly. • With high discount rate, an environmental policy proposal could be rejected; • With low discount rate, an environmental policy proposal may be implemented; The selection of discount rate is critically important to benefit cost analysis.
Two policy evaluation criteria:
To achieve *allocative efficiency* Maximize the present value of net benefits *To achieve cost-effectiveness* Minimize the present value of costs based on a pre- established benefit objective.
Solve for dynamic efficiency
We need to set two equations
Pollution prevention (P2)
is a long-term strategy aimed at reducing or eliminating the amount or toxicity of residuals at their source. - A shift from end-of-pipe to front-end
Sustainable development
is based on the premise that economic growth and environmental quality must be reconciled. It is a challenging environmental objective. The empirical estimation shows that per capita income level has to grow by at least 2% per year to reduce poverty; the world population grows at 1.7% each year. If we assume the following relationship among population, income growth, and environmental quality, then environmental impact per unit of income must decline at a rate 3.734% to avoid further negative environmental impact.
Inflation
is the increase in the general level of prices for goods and services over time. The $100 bill's purchasing power is decreasing over time, or you can say, generally speaking the goods are getting more expensive over time.
The philosophy of this selfish allocation
is to satisfy the current generation's needs and consider nothing about the future generation.
*Economic prosperity*
is typically measured as the growth rate of GDP (Gross Domestic Product).
• National Accounting
is utilized to keep *track of how a country's economy is performing*, including GDP changes. - Only measures the *marketable* goods so it is not the appropriate measure of social *well-being*.
*National Accounts*
only measure the economic outputs, not the social welfare.
*Technology Transfer*
refers to the advancement and application of technologies and strategies on a global scale. - Critical to consistent progress toward sustainable development
*Environmental Literacy*
refers to the awareness of the risks of pollution and natural resources depletion. - The promotion of environmental education across the world.
BCR:
shows the net benefit in a per dollar of cost incurred' format.
NPV:
tells the absolute dollar value of net benefits.
Inflation is measured as an annual percentage increase rate:
the inflation rate.
Toxic chemical use substitution:
the practice of substituting less harmful chemicals for toxic ones
Source reduction:
the preventive strategy to reduce pollutants at point of generation
If consumers believe there is very little or no substitution between C and E
then sustainability will be very difficult to achieve.
Discounting
• Inverting the problem of compounding, we get a problem of discounting. • How much money a person must invest now to achieve a specific value in the future? • Having $210 a year later is equivalent to having a $200 now. • The interest rate used in discounting is also called a Discount rate.
For a Dynamic Efficiency in a two periods model:
• Marginal Net Benefit in Period 1 = Present Value of Marginal Net Benefit in Period 2
Private projects (on private goods)
• Net Present Value is calculated by using market interest rate, which is decided by trading activities in the financial market.
3. Green Chemistry Program
• Seeks safer alternatives to hazardous chemicals, resulting in lower risks, safer production processes, and final products that pose less of a threat at the end of their economic lives.
Life Cycle Assessment (LCA)*
• To put closed materials flow into practice, a life cycle assessment should be undertaken. • LCA examines the environmental impact of a product or a process by evaluating all its stages from raw materials extraction to disposal. • The *International Organization for Standardization* developed voluntary standards for environmental management. • *ISO 14000 series* of environmental management standards are intended to assist organizations manage the environmental effect of their business practices.
Time value of Money
• Today's $1 is worthy more than Tomorrow's $1. People prefer to receive benefits sooner than later . • Money received now can be invested. • The later a benefit comes, the greater uncertainty of the likelihood of enjoying the benefit. Present value determination •The discounting!
• Still several initiatives and approaches are developed around the world to move the policymaking into the right direction.
─ Industrial Ecology ─ Pollution Prevention