1 Some further definitions are important: –Willingness to pay and Willingness to accept Other useful definitions: –Natural Capital –Environmental Impacts –Assimilative Capacity –Pollution Topic 1(g): The Economy and the Natural System

2 So far we have discussed that the demand curve reflects the Marginal Willingness to pay (MWTP) of a consumer. WTP is the amount of money a person would give away to get good x As we discussed a person’s WTP is equivalent to the value that this person poses on a good. That is, the benefit this person receives from the good. We are implicitly assuming that this person does not own the good (he has to pay for it) Topic 1(g): The Economy and the Natural System

3 However the value to a consumer can also be measured by what we call willingness to accept (WTA). Willingness-to-accept is the amount of money the person would have to be given in exchange for giving up x Clearly WTA assumes that the person owns the good. WTP is the appropriate measure of value if the person does not currently own the resource. WTA is the appropriate measure of value if currently the person does own the resource. Topic 1(g): The Economy and the Natural System

4 WTP and WTA depend on both the person’s preferences, the amount of wealth he owns and the property rights of good x. Property rights over environmental resources are rarely specified so the choice between WTP and WTA is never clear. WTP is bounded by income. WTA is not bounded so the difference can be very large. For example: How much a person is WTP not to die is bounded by the amount of money he has. Presumably the WTA to die (giving up good x or not to die) is infinite.

5 The dependence of WTP and WTA on wealth often generates considerable criticism of these measures of value. For example, these measures imply that the same pollution has a higher cost in rich countries than in poor countries. Why do economists use these measures when they apparently have such inequitable properties? The answer lies in the distinction between economic efficiency and the distribution of wealth Topic 1(g): The Economy and the Natural System

6 The relationship between the economy and the natural system is governed by the laws of nature. Central to that relationship is the notion of materials balance –Adaptation of the “first law of thermodynamics”: matter is neither created not destroyed in chemical reactions; it is simply transformed The economy draws upon natural capital and reconfigures that natural capital to produce services to satisfy human wants. Natural capital comprises “natural resources”, including air, water, fertile land, forests, fisheries, mineral deposits and fossil fuel resources Any utilization of natural capital must be accompanied by an environmental impact because materials must balance in the natural system.

7 Topic 1(g): The Economy and the Natural System Consider an example. The combustion of natural gas (methane) to produce heat –CH 4 +2O 2 → CO 2 +2H 2 O+Heat The purpose is heating, water and CO2 are by- products The reconfiguration of natural capital and its associated environmental impact are not exclusively anthropogenic processes. An example is forest fires caused by lightning. We will refer to the by-products of an economic reconfiguration process as “waste”

8 Topic 1(g): The Economy and the Natural System The ongoing reconfiguration of natural capital in the natural system also means that the natural system acts as a recycling process. –For example, the process of photosynthesis by plants is essentially one of reverse combustion. The recycling role of the natural system means that it is possible for the economy to continually reconfigure natural capital for human purposes, and for that reconfiguration to be continually reversed through the natural system. There are limits to the rate at which materials can be recycled through the system. That is, the system has limited assimilative capacity. A flow of waste in excess of assimilative capacity is pollution

9 Topic 1(g): The Economy and the Natural System Limited assimilative capacity does not necessarily mean that there are limits to growth in economic services. Continual growth in economic services may be possible via the substitution of knowledge capital for natural capital: –fuel efficiency; computing power This substitutability between natural capital and human capital means that sustainable development – defined as “sustained growth in the well-being of humans with no net depreciation in the capacity of natural capital to support that well-being” – may be feasible, at least in principle.