1. Welfare Economics and Sustainability

2. Terms & Concepts Resources, Market commodities and services, Externalities, Public Goods, Policies Production, Consumption, Cost, Profit, Economic Surplus, Utility, Welfare Indifference curve, possibility frontier

3. Production Economics Profit maximization  Cost minimization Efficiency implies –Using a given amount of resources, one cannot produce more of one good without producing less of at least some other good All possible efficient production decisions form the production possibility frontier

4. Normal Production Function X 1 Production Factor 1 X 2 Production Factor 2 Y=Y A Y = f(X 1,X 2 ) Y=Y B Y=Y C Y A > Y B > Y C

5. Leontief Production Function X 1 Production Factor 1 X 2 Production Factor 2 Y = Y B Y = Y A Y=Min(X1/a,X2/b)

6. Cost function X 1 Production Factor 1 X 2 Production Factor 2 X 2 = C/r 2 -(r 1 /r 2 )*X 1 C = r 2 *X 1 +r 1 *X 1

7. Normal Production Function X 1 Production Factor 1 X 2 Production Factor 2 Y=Y A Y = f(X 1,X 2 ) Y=Y B Y=Y C Y A > Y B > Y C

8. Leontief Production Function X 1 Production Factor 1 X 2 Production Factor 2 Y = Y B Y = Y A Y=Min(X1/a,X2/b)

9. Production Possibility Frontier Y 1 Production Good 1 Y 2 Production Good 2 Y A = f(X A ) Y = (Y 1,Y 2 ) = f(X 1,X 2 ) = f(X) Y B = f(X B ) Y C = f(X C )

10. Production Possibility Frontier Y 1 Production Good 1 Y 2 Production Good 2 Y A = f(X A ) Leontief Production Function Y B = f(X B ) Y C = f(X C )

11. Revenue (R) Y 1 Production Good 1 Y 2 Production Good 2 R = p 1 *Y 1 +p 2 *Y 2 Y 2 = R/p 2 -p 1 /p 2 *Y 1

12. Optimal Production Level Production Good 1 Y 2 Production Good 2 Y2*Y2* Y1*Y1*

13. Optimal Production Level Y 1 Production Good 1 Y 2 Production Good 2 Leontief Production Function

14. Utility Economics Utility (U) function of a person can be measured and depends on consumption (C) of goods and services –market and non-market goods Social welfare (SW) function can be measured and depends on utility of all people in a society –may include expected utility of future people

15. Utility (U) Indifference Curves Consumption Good 1 Consumption Good 2 U = U B U = U C U = U A U = U(C 1,C 2 )

16. Budget (B) Constraint Consumption Good 1 Consumption Good 2 p 1 *C 1 +p 2 *C 2 ≤ B C 2 ≤ B/p 2 -(p 1 /p 2 )*C 1 B/ p 2 B/ p 1

17. Optimal Consumption Levels Consumption Good 1 Consumption Good 2 U = U B U = U C U = U A C1*C1* C2*C2*

18. Utility Possibility Frontier (UPF) Shows the maximum utility of agents for a given amount of outputs Combining all utility possibility frontiers yields the grand utility possibilities frontier (GUPF)

19. Pareto Efficiency / Optimality No pareto improvement (PI) possible No change in the allocation of goods and services can improve the utility of at least one person without decreasing the utility of at least another person Vilfredo Federico Damaso Pareto (1848 1923) was an Italian engineer, sociologist, economist, and philosopher

20. Pareto Optimality Strong: no alternative allocation of goods where at least one is better and no one is worse off Weak: no alternative allocation of goods where all are better off Actual: true PI without compensation Potential: compensation possible Kaldor-Hicks Criterion: judge policy efficiency using potential PI

21. Social Welfare Function represents the joint utility of several (many, all) people includes implicitly or explicitly equity (fairness) considerations developed by Abram Bergson (1938,1948, 1954), Paul Samuelson (1947, 1950, 1956), Gerhard Tintner (1946) and Jan de Van Graaff (1957) "Bergson-Samuelson" social welfare function SW = SW(U 1, U 2,..)

22. Social Optimum First Fundamental Welfare Theorem: every competitive equilibrium is Pareto- optimal. Second Fundamental Welfare Theorem: every Pareto-optimal allocation can be achieved as a competitive equilibrium after a suitable redistribution of initial endowments.

23. Social Welfare (SW) Function, 1 Utility Person 1 Utility Person 2 SW Indifference Curves SW = SW B SW = SW A 45°

24. Social Welfare (SW) Function, 2 Utility Person 1 Utility Person 2 SW = SW B SW = SW A

25. Social Welfare (SW) Function, 3 Utility Person 1 Utility Person 2 SW = SW B SW = SW A

26. Social Optimum Utility Person 1 Utility Person 2 SW = SW B SW = SW A Grand Utility Possibility Frontier

27. Externality – Definition, 1 Definition in terms of effects : “an externality is present whenever some economic agent (say A’s) welfare (utility or profit) is affected by real (ie. non- monetary) variables whose values are chosen by others without particular attention to the effects on A’s welfare”

28. Externality – Definition, 2 Definition in terms of cause: “an externality is present whenever there is insufficient incentive for a potential market to be created for some good and the non-existence of the market leads to a non Pareto optimal equilibrium”.

29. Externality and Property Rights Private property rights absent for external goods (transaction cost higher than private benefits from internalization) Without property rights there is no market Without market, allocation of good is not efficient (Market failure)

30. Examples a construction company trucking through a private garden a farmer polluting ground water through excess fertilization Similar events but different outcomes.

31. Externality Types positive (beneficial) or negative (harmful) consumption or production related depletable (private) or non-depletable (public) stock or flow related point or not point source

32. Agricultural Externalities are often negative (water, air, and soil pollution, biodiversity, habitat reduction, erosion) can be positive (open landscape, emission sink) relate to production are mostly non-depletable arise from non-point sources local (odor), regional (water), or global (GHG)

33. Pesticide Externality, 1 Use of pesticides by farmer A wipes out pests that might affect farmer B. positive? production externality primarily a flow externality (plus a possible stock effect by reducing the breeding pool) local depletable (private)

34. Pesticide Externality, 2 Use of pesticides by farmer A increases pesticide resistance, reducing effectiveness of pesticides available to other farmers. negative a production externality a stock effect (resistance arises through cumulative use) mutual (farmer A is affected too) wider-than-local, potentially global non-depletable?

35. Fertilizer Externalities Decrease in species diversity, promotion of few fast growing grasses Eutrophication/Hypoxia (Fish killing) Increase leaching of potassium and calcium (mobilizing aluminum) Human health effects (nitrite poisoning of babies)

36. Fertilization: Costs and Benefits 0

37. Marginal Effects Marginal private benefit = Marginal social cost Marginal private benefit = marginal private cost Value 0

38. Fertilizer Externality Effects Social and private marginal costs of fertilization differ - so prices reflect private costs, not social costs. Individual profit maximizing behavior leads to Pareto inefficiency.

39. Leakage unintended flows of economic activities across space, time, and/or sectors and their consequences for non-market goods and services relates to commodity trade and can be couteracted through trade policies, i.e. so- called border tax adjustments

40. Scope of Sustainability Efforts Time (Current period – Entire Future) Space (Local – Global – Universal) Commodities (Individual – All) Resources (Individual – All) Externalities (Individual – All)

41. Scope of Sustainability Efforts Time (Current period – Entire Future) Space (Local – Global – Universal) Commodities (Individual – All) Resources (Individual – All) Externalities (Individual – All) Leakage High Low