Ecological Economics Lecture 07 Tiago Domingos Assistant Professor Environment and Energy Section Department of Mechanical Engineering Doctoral Program.

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Ecological Economics Lecture 07 Tiago Domingos Assistant Professor Environment and Energy Section Department of Mechanical Engineering Doctoral Program and Advanced Degree in Sustainable Energy Systems Doctoral Program in Mechanical Engineering Doctoral Program in Environmental Engineering

Inflation – changes in consumer prices Affects: –Exports, –Erosion of consumer power –Distorts the intertemporal comparisons of variables in monetary units, e.g., evaluating the profitability of an investment. What part of the change in national accounts aggregates at current prices comes from a change in the quantities (changes in volume) produced and what part comes from a change in prices (inflation)? Temporal Comparison - Real vs Nominal

What is the nominal GDP in each year and the nominal GDP growth rate? What does the above value represent? How to obtain real (volume) growth changes? Temporal Comparison - Real vs Nominal ItemQuantityPrice 2007 Bread100€1.00 Butter20€5.00 2008 Bread160€ 0.50 Butter22€ 22.50 Nominal GDP in: - 2007, €200 - 2008, €575 Growth rate: 187,5 %

Consumer Price Index (CPI) –It is based on a fixed (changes every 5 years) basket of goods that are normally an important part of households’ consumption. 1 – Fix the Basket – which prices are most important to the typical consumer? Put weights by surveying consumers and finding the basket of goods and services that the typical consumer buys. 2 – Find the prices for each good and service in the basket. 3 – Compute the basket’s cost (price times quantity) 4 – Choose a base year and compute the CPI Formula 5 – Compute inflation as the rate of change in CPI Price Level and CPI

Basket of goods: 5 Breads, 1 Butter What is the inflation rate? Inflation rate = rate of change of price level, 150% = (250-100)/100 Price Level and CPI ItemQuantityPriceCost of BasketCPI 2007€10100 Bread100€1.00 Butter20€5.00 2008€25250 Bread160€ 0.50 Butter22€ 22.50

Using the CPI to deflate V year x to V base year : V base year = (CPI base year ÷ CPI year x ) V year x. What is the real GDP and its real growth rate? 15 % What does the above value represent, compared to nominal growth 187,5%? Price Level and CPI ItemNominal GDPCPIReal GDP 2007 €200100€200 2008 €575250€230

First national CPI (PT) in 1977, after “inquérito às despesas das famílias” 1973/1974. Increase in number of items, establishments and reference population Now: Fixed base year using average prices of 2008 (Changed in 1976, 1983, 1991, 1997) CPI is in fact composed of several indexes for different classes of consumption (COICOP - Classification Of Individual COnsumption by Purpose) More than 700 items (goods and services) in more than 10 000 establishments yielding more than 70 000 prices on a monthly basis for a given reference population (total population). These basket is changed every 5 years. CPI in Portugal

CPI in Portugal: Basket COICOP (1) Divisions, Groups and ClassesYear: 2009 JanFebMarApr Food and non alcoholic beverages99,999,498,898,3 Food99,999,498,898,2 Bread and cereals101,1101,3101,1101,2 Meat101,8100,299,799,4 Fish98,998,495,593,4 Milk, cheese and eggs99,097,396,495,3 Oils and fats98,296,494,493,1 Fruit95,896,197,998,7 Vegetables100,7102,8104,9105,3 Sugar, jam, honey, chocolate and confectionery101,1 100,9101,0 Food products n.e.c.99,599,9100,4100,7 Non-alcoholic beverages100,199,8100,0100,7 Coffee, tea and cocoa101,5101,0100,8101,6 Mineral waters, soft drinks, fruit and vegetable juices99,699,399,7100,4 Alcoholic beverages, tobacco101,4101,5103,1 Alcoholic beverages102,4102,5102,4 Spirits99,9101,2100,199,5 Wine103,0 103,5103,7 Beer101,9101,4100,4100,1 Tobacco101,0 103,2103,3

Clothing and footwear88,585,8103,0103,7 Clothing87,785,1103,2103,8 Clothing materials101,0100,3100,2102,0 Garments87,184,3103,4104,0 Other articles of clothing and clothing accessories88,287,595,797,5 Cleaning, repair and hire of clothing100,8101,1101,2101,4 Shoes and other footwear including repair and hire of footwear90,987,8102,2103,4 Footwear90,687,5102,2103,4 Repair and hire of footwear102,2102,5102,6102,7 Housing, water, electricity, gas and other fuels101,8101,9102,0101,9 Actual rentals for housing101,4101,7102,2102,4 Actual rentals paid by tenants including other actual rentals101,4101,7102,2102,4 Maintenance and repair of the dwelling101,4 101,5101,8 Materials for the maintenance and repair of the dwelling101,9102,0102,2102,6 Services for the maintenance and repair of the dwelling101,1 101,3 Water supply and miscellaneous services relating to the dwelling103,2104,0104,4104,6 Water supply101,9102,9103,4103,6 Refuse collection (2) 101,4101,8102,6103,9 Sewerage collection (2) 102,5104,4104,7 Other services relating to the dwelling n.e.c.105,5 Electricity, gas and other fuels101,0100,8100,5100,1 Electricity104,2 Gas95,194,5 92,6 Liquid Fuels (2) 97,296,490,995,0 Solid fuels100,2100,598,498,6

Furnishings, household equipment and routine maintenance of the house101,9101,7101,8 Furniture and furnishings, carpets and other floor covering99,899,499,6 Furniture and furnishings99,899,499,699,5 Carpets and other floor coverings99,498,898,199,5 Repair of furniture, furnishings and floor coverings101,9102,3102,4102,8 Household textiles100,399,398,899,4 Household textiles100,399,398,899,4 Household appliances100,5100,4100,5100,4 Major electric household appliances100,4100,2100,3100,1 Small electric household appliances100,6100,7101,0100,9 Repair of household appliances101,5102,4102,6102,8 Glassware, tableware and household utensils100,8 100,9101,1 Glassware, tableware and household utensils100,8 100,9101,1 Tools and equipment for house and garden101,6101,9101,8101,9 Major tools and equipment for house and garden100,3100,2100,499,9 Small tools and miscellaneous101,7102,3102,1102,5 Goods and services for routine household maintenance103,5103,4103,5 Non-durable household goods100,4100,0100,4100,3 Domestic services and household services105,6 105,7

Health99,699,3 99,4 Medical products, appliances and equipment98,298,398,298,4 Pharmaceutical products97,2 97,097,1 Other products and medical appliances101,3101,4 101,1 Therapeutic appliances and equipment101,1101,3101,6101,9 Out-patient services100,7100,9 101,1 Medical services100,9101,3101,4101,5 Dental services100,7 100,9 Paramedical services100,0100,2 100,3 Hospital services100,795,7 95,9 Transport93,694,794,495,7 Purchase of vehicles101,5101,4101,3101,1 Motor cars101,5101,4101,3101,1 Motor cycles100,6101,2101,8102,9 Bicycles100,8100,499,698,9 Operation of personal transport equipment86,288,087,689,8 Spare parts and accessories98,197,596,796,2 Fuels and lubricants78,680,980,383,1 Maintenance and repair of personal transport equipment100,8101,2102,1102,7 Services in respect of personal transport equipment101,8101,9102,0102,1 Transport services95,997,796,898,3 Passenger transport by railway101,0101,7 Passenger transport by road102,8103,3103,4 Passenger transport by air79,785,882,088,0 Passenger transport by sea and inland waterway103,2103,5 105,9 Combined passenger transport100,1 Other purchased transport services99,1 99,3

Communication98,398,299,3 Postal services102,2103,9 Postal services102,2103,9 Telephone and telefax equipment89,088,688,589,0 Telephone and telefax equipment89,088,688,589,0 Telephone, telegraph and telefax services98,498,399,5 Education102,5102,7 Pre-school and primary education102,8 Pre-school and primary education102,8 Primary and secondary school100,9101,2 Primary and secondary school100,9101,2 Higher education103,0 Higher education103,0 Other types of education102,6103,1103,2103,4 Other types of education102,6103,1103,2103,4 Hotels and restaurants101,3101,5101,9102,4 Catering services101,7102,1102,4102,5 Restaurants, cafes, bars and like101,2101,5101,9102,0 Canteens106,1106,3106,5106,7 Accommodation services89,587,089,698,9

Recreation and culture99,1 98,498,6 Audio-visual, photographic and data processing equipment96,194,292,292,0 Equipment for the reception, recording and reproduction of sound and pictures96,094,692,592,1 Photographic and cinematographic equipment and optical instruments90,991,190,088,8 Data processing equipment92,590,287,987,4 Recording media for pictures and sound99,096,694,895,7 Repair of audio-visual, photographic and data processing and accessories102,7103,2103,7104,6 Other major durables for recreation and culture98,098,498,9 Major durables for outdoor recreation (2) 100,0100,2 Major durables for indoor recreation including musical instruments97,698,499,399,4 Other recreational items and equipment, garden and pets102,1103,3100,099,7 Games, toys and hobbies, equipment for sport camping and open-air recreation97,095,895,694,7 Other recreational items for hobbies and recreation98,898,9 99,3 Gardening108,7115,298,194,4 Pets and related products102,1102,6102,7103,8 Recreational and cultural services99,8100,2100,3101,3 Recreation and sporting services98,4100,1100,4100,3 Cultural services100,4100,6100,7102,6 Games of chance100,0 Newspapers, books and stationery102,1102,0101,5101,7 Books101,6101,3100,0100,4 Newspapers and periodicals103,5103,6 103,7 Miscellaneous printed materials100,6100,7101,5101,6 Package holidays91,890,891,290,0 Package holidays91,890,891,290,0

Miscellaneous goods and services101,4101,5101,6101,9 Personal care101,2101,5101,8102,2 Hairdressing salons and personal grooming establishment101,2101,4101,7102,0 Articles for personal care101,0101,4101,3100,8 Products for personal care101,2101,6101,9102,3 Personal effects n.e.c.102,2100,8101,4102,1 Jewellery, clocks and watches104,1103,1103,2103,7 Other personal effects99,597,898,899,7 Social protection103,0103,1 Social protection services103,0103,1 Insurance100,5100,3 Insurance connected with the dwelling102,2 Insurance connected with health (2) 100,9101,7 Insurance connected with transport100,099,6 99,5 Other insurance (2) 100,6 Financial services n.e.c.100,7 100,8101,0 CPI in Portugal: Basket Example: Washing machine; white; frontal door; 5 kg of clothes; 2200 W; 12 – 14 programs Pants; Wool (45%) and polyester (55%), two lateral pockets; one back pocket, no fold; good finishings, 46/48.

Source: AMECO database Inflation rate in Portugal [%]

Real vs. Nominal (Portugal) [Mrd euros] Source: AMECO database

Objective: Measure changes in the cost of living Substitution bias: prices change differently consumers buy more of cheaper goods, yet the basket is fixed. Overstates the increase in prices Technological progress New goods more variety each € is more valuable since it buys more goods. E.g., introduction of VCRs CPI even with the revised basket never shows the decrease in life cost due to new products. Quality Change: Quality increases value of one € decreases even if the price of the good stays the same Prices are adjusted but quality is hard to measure No environmental goods, … Problems with the CPI

Present Value of Money Present Value –Conversion of money flows to their present value NPV: Net Present Value i: interest rate VF t (t): value at instant t If VF is in current prices then i is the nominal interest rate If VF is in constant prices then i is the real interest rate

Nominal vs. real interest rates The Fisher relation For low rates, this is approximately equal to

Present Value of Utility Welfare –Discrete time –Continuous time

Discount Rate Justification and Components The same monetary flow at different instants does not have the same value (time preference) –CONSUMPTION: Uncertainty Being alive in the future (individual vs. society) Preferences in the future Value of the benefit or the cost –CONSUMPTION: Impatience –PRODUCTION: Capital productivity (opportunity cost of capital) Under certain conditions, the discount rate is equal to the real market interest rate consumption discount rate per capita consumption growth rate elasticity of the marginal utility of consumption utility discount rate Turner et al. (1994), pp. 102-106. pure time preference rate variation in survival probability

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