lecture 1.pdf

Energy and Environmental Economics Course organisers: Ruth.dittrich@sruc.ac.uk Peter.Alexander@sruc.ac.uk Harry van der Weijde h.vanderweijde@ed.ac.uk

LECTURE 1

Part 1: Principles of economics (Ruth Dittrich)

�  Lecture 1: Introduction to economics �  Definitions and some history of economics �  Guest lecture

�  Lecture 2: Theory of consumer behaviour �  Preferences, budgets and utility maximisation

�  Lecture 3: Foundation of welfare economics �  Pareto efficiency, consumer welfare

�  Lecture 4: Cost-benefit analysis �  Foundations of cost-benefit analysis �  How to evaluate environmental goods

Part 2: Pollution control (Peter Alexander)

� Lecture 1: Theory of firm behaviour �  What guides firms behaviour and the impact of

market structure?

� Lecture 2: Instruments of pollution control �  What is the socially optimal level of pollution and how

might it be achieved?

� Lecture 3: Climate change negotiation exercise �  Gain insights into some of the economic and ethical

issues in emissions controls

Part 3: Energy Economics (Harry van der Weijde)

� Lecture 1: Introduction to world energy markets �  How have worldwide oil, gas, coal markets evolved

and how do they currently work?

� Lecture 2: Economics of electricity �  How do various electricity markets work and interact

with physical electricity networks/systems?

� Lecture 3: Investment and regulation in energy markets + ethical issues �  What are current issues around investment and

regulation and how do we solve them? �  What are important ethical problems?

Formalities �  2 hour written exam at the end (100 %) �  Revision lecture at the end of term

�  Office hours: after the lecture in the LT, otherwise please email me to make an appointment: ruth.dittrich@sruc.ac.uk

� 1h tutorial every second week, Wednesday

mornings

Tutorial structure � Questions provided ahead of every

tutorial for you to work through on your own

� Questions will be concept focused

� Questions will be discussed in class in smaller groups

Reading (for the first part of the course) �  Edwards-Jones, G., Davies, B. and Hussain, S.S. (2000)

Ecological Economics: An Introduction. Oxford: Blackwell Science.

For consumer theory, any microeconomics text book, for example:

�  Pindyck, Robert S. and Rubinfeld, Daniel L. (2005) Microeconomics. New Jersey: Pearson Education International

For cost-benefit analysis also:

�  Cost-Benefit Analysis: Concepts and Practice by A. Boardman, D. Greenberg, A. Vining, D. Weimer

Reading list on LEARN

What is economics?

� The study of how individuals and societies make decisions about ways to use scarce resources to fulfil wants and needs.

What does THAT mean?

What are resources? � The things used to make other goods

✚

Scarcity � Unlimited wants and needs but limited resources

Choices � Because ALL resources, goods, and services

are limited – we must make choices!

Why choices? We make choices about how spend our money, time, and energy so we can fulfil our NEEDS and WANTS. NEEDS: ‘stuff’ we must have to survive generally: food, shelter, clothing WANTS: ‘stuff’ we would really like to have (fancy food, shelter, big screen TVs, Iphone…)

Questions Society (we must figure out) � WHAT to produce � HOW to produce it � HOW MUCH to produce � FOR WHOM to produce � WHO gets to make these decisions?

Trade-offs You can’t have it all (scarcity) so you have to choose how to spend your money, time, and energy. These decisions involve picking one thing over all the other possibilities – a TRADE OFF

What could you have done instead of coming to this lecture?

These are all trade-offs! Thanks for being here!

The value of the Next Best Choice � Example: Sleeping is the opportunity cost

of studying for an exam.

�  The basic relationship between scarcity and choice: doing one activity means not doing another activity.

�  It is the "cost" incurred by not enjoying the benefit that would be had by taking the second best choice available

�  This can be time, energy, or even money. �  If you decide not to go to work, the opportunity cost is the

lost wages. �  Tony buys a pizza and with that same amount of money

he could have bought a Coke and a hot dog. The opportunity cost is the Coke and hot dog.

Opportunity cost

Sunk cost � A cost that has already been incurred

and cannot be recovered.

� The cost is irrelevant for all decisions about the future.

Production � How do we get all the ‘stuff’ that we have

to decide about?

Production � Production how much a individual,

business, country, the world makes.

� Goods (tangible products we can buy)

� Services (work that is performed by others)

Process � Factors of production (capital, land,

labour) � Producer (company that makes goods/

services) � Households (people who buy goods/

services and work of the producers

The circular flow

Households consumers Firms

Labour

Wages

Purchases

Goods/services

Positive and normative statements � POSITIVE

�  If the cost of doing a Masters rises in Edinburgh then less students will embark on the programmes

� NORMATIVE �  The fees ought to stay high as Edinburgh University

ought to only attract the rich/elite (!)

Why Economists Disagree

�  In some cases, the disagreement may be positive in nature because �  Our knowledge of the economy is imperfect �  Certain facts are in dispute

�  In most cases, the disagreement is normative in nature because �  While the facts may not be in dispute

� Differing values of economists lead them to dissimilar conclusions about what should be done

Positive And normative statements �  University education should be free!

�  If the government raises the tax on beer, this will lead to a fall in profits of the brewers.

�  The retirement age should be raised to 70 to combat the effects of our ageing population.

�  Pollution is the most serious economic problem

�  A fall in incomes will lead to a rise in demand for own-label supermarket foods

A glimpse into economic thought

Classical Political Economy (18th to 19th century)

�  Still influential on current thinking in economics �  Adam Smith, Thomas Malthus, David Ricardo,

John Stuart Mill �  Role of the market mechanism

�  Efficient resource allocation mechanism �  Stimulus to growth in consumption

�  Limited capacity to the market to continue growing �  Stationary state �  Land, and natural resources in general, were

seen to be vital determinants of the wealth and growth of nations

Adam smith (1723 – 90): ‘The invisible hand’

Smith and the free market

� Self-interested behaviour by an individual serves to satisfy that individual’s want AND coincides with the interests of society at large.

� Thereby an ‘invisible hand’ coordinates the operation of a market economy to maximise its output.

� But its an accidental property of freely functioning markets.

Smith: The role of the state � State should not act as a burden on

individuals � Provision and operation of the judicial

system, national defence, provision of infrastructure and other public goods

� A ‘nightwatchman’ state �  Issues:

�  Ownership �  Market power �  Natural resources

Karl Marx (1818-1883)

� Profound impact on politics �  Industrial Revolution: capitalist classes

exploited the working class to achieve high level of consumption and political power

� Capitalism as a modern form of feudalism that will eventually lead to revolution.

Marx communist vision � Class free society � Abundant resources distributed

according to citizen’s need. � Labour factor input is the only source of

net income in the economy � Neo-Marxist theory: environmental

impact as another form of social suppression of the labouring class under capitalism �  ‘footloose capital’

Neoclassical economics �  Mainstream economic thought (mid 19th

century and after). �  Economy works best without state

intervention with the individuals making rational decisions.

�  Value of a commodity also stems from the utility it yields to the consumer and not only from the labour input needed to produce it.

�  Brings supply (value of labour theory) and demand (utility based) together with price being determined by both.

�  The price mechanism yields incentives for innovation to generate substitutes for scarce commodities.

The allocative system � price gives signals � demand and supply interactions

determine price

£

quantity

supply demand

0

Neoclassics and welfare economics �  It’s about the well-being of society: does the

economy raise welfare? � Pareto-efficiency: a situation in which given the

initial distribution of resources no person could be made better off without making at least one other person worse off.

� This doesn’t necessarily imply an equal distribution.

� Redistribution is a normative political/ethical question for neoclassical economists.

Institutional economics �  Origins in early 20th century �  Focuses on relationship between institutions and human

behaviour �  Institutions are organisational systems for behaviour

�  Formal systems such as the legal constitution and regulations

�  Informal institutions like tradition, habits, moral norms and social codes.

�  Interested in how institutions have developed and influence the market instead of a framework for a functioning market.

�  Unable to match the rigour and predictive power of neoclassical economics.

Emergence of an ecological conscience

� 1960s/1970s: entire economic system is itself embedded within the wider environmental system.

� Club of Rome (1968, 1972): The limits of growth

� Kenneth Boulding: The space ship economy (1966)

� Herman Daly (1973): Toward a Steady State Economy

Kenneth Boulding and Space ship earth � Kenneth Boulding

�  Traditional analysis: Cowboy economy

Economy

Waste Raw Materials

The spaceman economy

corrected circular flow: the Spaceman economy

Recycling

Implications of the spaceman economy

� Earth is a closed system with limited opportunities for exchanging materials and energy with areas outside the system.

� Environmental impacts of economic activity must be kept within some limits.

� What are those limits? �  (1) If we are unsure about total stock/recycling

capacity of the earth, minimise the throughput of material and use it as efficiently as possible.

�  (2) The higher the total capital stock on board, the better.

So what’s ecological economics?

“There are no passengers on spaceship Earth. We are all crew.” (Marshall McLuhan). �  A transdisciplinary field of study which examines

the interactions between economic and ecological (and liked to this the social) systems from a number of related viewpoints.

�  Central problems of unsustainable human impact on the natural environment

�  No supremacy of any discipline but assumption that they are mutually supportive.

…And Environmental Economics? �  Sub-discipline of (neo-classical) economics. �  Efficient allocation of natural resources, e.g.

forest and fisheries management in a supply and demand framework.

�  Theoretical and empirical studies on the economic effects of environmental policies around the world.

�  Understanding the causes of, and designing policy solutions to, contemporary environmental problems.