Economics and Cost benefit analysis for climate changes: an introduction, part II

Size: px

Start display at page:

Download "Economics and Cost benefit analysis for climate changes: an introduction, part II"

Sharleen Glenn
5 years ago
Views:

1 Economics and Cost benefit analysis for climate changes: an introduction, part II Luciano Pasi, Ph.D of September 2016 The Metropolitan Hotel, Ankara

2 From revealed preferences to Utility functions Markets allow for the fundamental decisions of the economy to be taken by a decentralized mechanism: But when public goods and externalities are present (almost always!) markets do not exist at all or they do not produce efficient solutions (what? How much?). We are left with two solutions, non necessarely divergent: a) let somebody decide for the people. A good dictator in economic literature is a mechanism that uses some information about the people preferences and produces the right decision. Political institutions helped by commissions of technicians is a usual method in the west; they depend heavily on the voters judgements that are often ill informed b) use as much as possible the preference of individuals to reach an optimal outcome

Remember that the whole point of CBA is to produce an outcome, a decision that is as much close as possible to the production possibility frontier.

3 Remember that the whole point of CBA is to produce an outcome, a decision that is as much close as possible to the production possibility frontier. A necessary condition for this is to consider individual preferences: exactly what happens in private goods markets Q1= money spent in mitigation policy 1: increase the tax on gas and diminish GHG from transport Q2= money spent in mitigation policy 2: manage forests to Increase their capacity of stocking carbon How to choose between these outcomes? A purely political system may care only to reach an outcome and use it for the next election day

4 Preferences of individuals Assumptions on preferences: a) completeness b) transitivity c) reflexiveness d) continuity These properties translate into monotonicity and convexity of Utility functions Choices But working with preferences is hard: they are not manageable mathematical objects. This is why we derive Utility functions form them If the assumptions are satisfied then we can build Utility functions that represent individual preferences by mapping the space of all goods and services (or alternative choices, states) to the real numbers

5 An equivalent representation of the UF is given by the indifference curves If X is n dimensions space of consumption, then a utiliy function of an individual is a mapping from X to R, the real numbers

6 Aggregating Utility of individuals: social welfare functions SWF play the same role of UF, but for all individuals of a society: they map individual utilities into a subset of real numbers. The form of this mapping is highly debated. Some examples: n SWF = 1 i=1 Y i SWF 3 =min(y 1,Y 2,...,Y n ) SWF 2 = 1 n n i=1 Y i SWF 4 = 1 n n i=1 Y i (1 Gini)

7 It must be clear that data from CBA (costs and benefits) enter as input into the utility functions of individuals: these last ones are input of the chosen SWF, so that the results of maximization of SWF and of successive policy choices are highly dependant from the choice of the form. Also, weighting for differences of average income of different nations can be done. If we do not do it, it is clear that awkward results can appear: the life of an Indian is valued at 1/20 of the worth of the life of the average european citizen; damages values based on european average income will be much higher of the same damages evaluated on the indian average income. As a result, a non-weighted SWF will lead to invest too much money into mitigation for Indian purposes: It will be an non efficient choice for Indians

8 The final step: overposing the PPF to the indifference representation of the social welfare function The black curves are the indifference representation of the chosen SWF The orange one is the only portion of the SWF that shares a point with the PPF The point with coordinates Q* maximizes the SWF given the constraints of the PPF. It tells us haw much we should spend for the 2 policies

9 Thank you Luciano Pasi, Ph.D.

Chapter 5: A Closed-Economy One-Period Macroeconomic Model

Chapter 5: A Closed-Economy One-Period Macroeconomic Model Introduce the government. Construct closed-economy one-period macroeconomic model, which has: (i) representative consumer; (ii) representative