Goals of today’s lecture Compare and contrast the “invisible hand” with the “tragedy of the commons”. Understand a bit about supply and demand and other market mechanisms. Environmental career fair next week! (Monday 1:30-3:00 alumni panel in MGH)Environmental career fair See some economics comedyeconomics comedy Announcements and clicker questions…

Town Hall prompts Global: Read these notes from the 2007 Bali conference. From the point of view of your stakeholder, respond to some of these policy proposals. Answer these questions: If the world community were to create a carbon cap and trade program, how would you be affected? Would you support it or oppose it? Do you agree more with the position of the American government or the EU? What additional or alternate policies might you suggest?these notes Local: Read Governor Gregoire's policy brief. From the point of view of your stakeholder, respond to some of the policies she sets out. If the Governor were to implement a carbon cap and trade program, how would you be affected? Would you support it or oppose it? What additional or alternate policies might you suggest?policy brief

The world’s 2 nd -biggest export commodity is… 1.Cotton 2.Oil 3.Paper 4.Corn 5.Coffee

Human interconnections (almost like an ecosytem!) is evident in… 1.“I, Pencil” 2.Stuff 3.Both readings

“Leave all creative energies uninhibited” is the message of… 1.“I, Pencil” 2.Stuff

Claim #1: Trade can make everyone better off Claim #2: Trade will make everyone better off Now, claim #2 is clearly better, so why is #1 used? ► Claim #2 must be false!! ►Trade can make some people worse off!!!! ►Trade can make everyone worse off!!!!!!! Proof. Compare the following: § Consider a small town with three families: Family #1 wants a snowblower, Family #2 wants a leafblower, and Family #3 wants a lawnmower; each family values their particular need at $200. It also just so happens that Family #1 owns a leafblower, Family #2 owns a lawnmower, and Family #3 owns a snowblower. These sit unused in their respective garages; each family has no use for its current equipment, and therefore values it at $0. The situation appears ripe for gains from trade! Unfortunately, life in this small town is not so simple: the town is located in a valley that is susceptible to severe air pollution problems. Blowers and mowers emit so much pollution that use of any one piece of equipment will increase hospital bills (for asthma &etc) by $80 for each family. Three additional blowers and mowers will therefore increase each family's bills by $240. Result #1: All three trades will still take place. For example, if Family #3 sells Family #1 its snowblower for $100 then each family gains $100 from the trade, minus $80 in hospital bills, for a net gain of $20. Result #2: The three trades together make everyone worse off: if each family sells its unused equipment for $100 and buys its desired equipment for $100 then each family gains $200 from its trades. But each family lose $240 in hospital bills, for a net loss of $40. Conclusion: Trade can make everyone worse off! §

Trade can make everyone worse off Orange, Pink, and Blue live in a small town with an air pollution problem. They also each have a garage full of gadgets they currently don’t use.

Trade can make everyone worse off 1.Orange sells a lawnmower to Pink

Trade can make everyone worse off Orange sells a lawnmower to Pink. 2.Pink sells a snowblower to Blue.

Trade can make everyone worse off Orange sells a lawnmower to Pink. 2.Pink sells a snowblower to Blue. 3.Blue sells a leafblower to Orange.

Trade can make everyone worse off Each person’s trades are individually rational, but all the trades together hurt everyone! - 40 Connection to climate change? China Europe USA

The Tragedy of the Commons 1.It’s better for the group as a whole if everyone makes Choice A rather than Choice B. 2.Each person individually prefers to make Choice B. In these situations, individual incentives lead people to make personal choices that are bad for the group as a whole.

Not every situation is a Tragedy of the Commons! In many situations, individual incentives lead people to make personal choices that are good for the group as a whole. Sometimes this happens because of the “hidden order” that comes out of free- market economics, Adam Smith’s “invisible hand” metaphor. And sometimes we just get lucky.

Is human population growth a tragedy of the common??? 1.It’s better for the group as a whole if everyone has just two children so that populations don’t continually rise: 6 billion, 12 billion, 24 billion, 48 billion… 2.Each person individually prefers to have 3 or more children. Is statement #2 true? Is statement #1 true?

How many children do you want? 1.One 2.Two 3.Three 4.Four or more 5.Zero (no kids) 6.Zero (adoption) 7.Unsure

Not every situation is a Tragedy of the Commons! In many situations, individual incentives lead people to make personal choices that are good for the group as a whole. Sometimes this happens because of the “hidden order” that comes out of free- market economics, Adam Smith’s “invisible hand” metaphor. And sometimes we just get lucky.

Adam Smith, The Wealth of Nations (1776) [Man is] at all times in need of the co-operation and assistance of great multitudes…The woolen coat, for example…is the produce of the joint labor of…[t]he shepherd, the sorter of the wool, the wool-comber or carder, the dyer, the scribbler, the spinner, the weaver, the fuller, the dresser, with many others…

Adam Smith, The Wealth of Nations (1776) …[But man’s] whole life is scarce sufficient to gain the friendship of a few persons… and it is in vain for him to expect [help from] benevolence only… …It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love,

Adam Smith, The Wealth of Nations (1776) …and never talk to them of our own necessity but of their advantages… [Man is] led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of it. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it.

A free-market experiment 1.Write down the last four digits of a phone number (yours or someone else’s). 2.If the first digit is even (02468), you are a seller. You own one fish and would like to see it for a profit. 3.If the first digit is odd (13579), you are a buyer. You would like to buy one fish if the price is right.

A free-market experiment Sellers, the 2 nd digit is your selling value, which is the minimum amount you are willing to sell a fish for. You want to try to sell one fish for as much as possible, but not less than your selling value. Example: My phone number is 0431, so I’m a seller and my selling value is 4.

A free-market experiment Buyers, the sum of the 2 nd and 3 rd digits is your buying value, which is the maximum amount you are willing to buy a fish for. You want to try to buy one fish for as little as possible, but not more than your buying value. Example: My phone number is 5790, so I’m a buyer and my buying value is 7+9=16.

A free-market experiment Sellers, you want to try to sell one fish for as much as possible, but not less than your selling value. Buyers, you want to try to buy one fish for as little as possible, but not more than your buying value. You may not be able to buy or sell. If you can trade, note the transaction price.

What was your transaction price? 1.$2 or less 2.More than $2, <= $4 3.More than $4, <= $6 4.More than $6, <= $8 5.More than $8, <= $10 6.More than $10, <= $12 7.More than $12 8.Couldn’t make a trade

What was your transaction price? 1.$2 or less 2.More than $2, <= $4 3.More than $4, <= $6 4.More than $6, <= $8 5.More than $8, <= $10 6.More than $10, <= $12 7.More than $12 8.Couldn’t make a trade

Observed phenomena (I hope!) The law of one price: Prices for the same good tend to converge to one price. This is an example of “hidden order”: instead of chaos, there is structure. Another example: during rush hour, lanes of traffic on the 520 bridge travel at about the same speed (“law of one speed”).

What determines prices? Diamond/water paradox: Water is more valuable than diamonds, so why is a glass of diamonds worth more than a glass of water? Are prices are determined by supply (cost of production)? By demand (willingness to pay)? Alfred Marshall: Which edge of the scissors cuts the paper?

Sellers: If the market price was $3, would you be willing to sell? 1.Yes 2.No

Sellers: If the market price was $6, would you be willing to sell? 1.Yes 2.No

Sellers: If the market price was $9, would you be willing to sell? 1.Yes 2.No

Sellers: If the market price was $12, would you be willing to sell? 1.Yes 2.No

Buyers: If the market price was $15, would you be willing to buy? 1.Yes 2.No

Buyers: If the market price was $12, would you be willing to buy? 1.Yes 2.No

Buyers: If the market price was $9, would you be willing to buy? 1.Yes 2.No

Buyers: If the market price was $6, would you be willing to buy? 1.Yes 2.No

Buyers: If the market price was $3, would you be willing to buy? 1.Yes 2.No

Observed phenomena (I hope!) The law of demand: The amount that buyers want to buy varies inversely with the market price. At lower prices, buyers want to buy more. At higher prices, buyers want to buy less. Similar incentives work on the supply side.

$3 $6 $9 $12 $15 Price per fish Quantity of fish bought or sold

Market forces are so strong… …you should think about using them to protect the environment! “Market mechanisms” can be used to correct externalities, align individual incentives with social goals. Example: ITQs in fisheries establish “private property rights” over the commons Example: Cap-and-trade or carbon taxes.

Fish tax example We’re going to use a fish tax to limit overfishing (“tragedy of the commons”). Should the tax be on the buyers or the sellers? Sellers: If you sell a fish, you now have to pay the government a $3 tax.

What was your transaction price? 1.$2 or less 2.More than $2, <= $4 3.More than $4, <= $6 4.More than $6, <= $8 5.More than $8, <= $10 6.More than $10, <= $12 7.More than $12 8.Couldn’t make a trade

Observed phenomena (I hope!) Reduced catch: The tax reduced the number of fish bought and sold. Market price increase: The sellers paid the tax, but they effectively passed part of it on to the buyers. This is an example of the tax equivalence result. Government revenue that can be used to reduce existing taxes or promote sustainable fisheries.