2. Basic economics

Question 2

What are the characteristics of the indifference curves?

Answer 2

1. The further the indifference curve is from the origin, the higher the Utility
2. The slope of the indifference curve is normally negative
3. The indifference curve is normally convex
4. The indifference curves do not intercept

Question 3

What is the Edgeworth box? what are its characteristics?

Answer 3

• The total available quantities of goods X and Y are finite and given –> X max and Ymax
• Rotating the indiff curve of a second consumer B at 180 degrees with its axis crossing the second consumer A’s indiff at the points:
  
  • I1 (0, XAmax) or ( 0, YBmax)
  • I2(0, YAmax)or (0, XA max)
    ​–> we got the Edgeworth box!
• We know that the slopes of the tangent indiff curves at certain points give us the MRS–> rate at which one good can be substituted by another. So for the Edgeworth box ath the points where the indiff curves A and B are tangent to each other we have: MRS_A =MRS_B
• The curve connecting all tangency points gives us the Contract curve with all pareto allocations.
• Outside the pareto allocation a re-allocation of goods is possible to make one consumer better-off without making the second worse-off
  watch: https://www.youtube.com/watch?v=zjGhjIAQpps

Question 4

Define the following:

• Efficiency
• Pareto improvement

Answer 4

• Efficiency: An allocation (e.g. of X and Y) is efficient if it not possible to make one or more persons better off by changing the allocation
• Pareto improvement:
  
  • A gain by one or more persons without anyone else suffering
  • Summation of all the gains–>Pareto optimal, or Pareto efficient

Question 5

Make analogies between achieving efficiency in consumption and production

Answer 5

• Efficiency in consumption:
  
  • X, Y: consumption goods
  • A, B: consumers
  • Indifference curve
  • MRS: Marginal rate of substitution
• Efficiency in production:
  
  • C, L: Labor, Capital–> production factors
  • A, B: Production firms
  • Indifference curve
  • MRS: marginal rate of technical substitution

Question 6

What is social optimal allocation?

Answer 6

it is an allocation that maximizes social welfare:

W= W(UA,UB)

with dW/dUA, dW/dUB >0

Question 7

How to maximize Net Gains from Emission level -e e.g. 550 ppm?

Answer 7

• Benefits B(e) and Costs C(e) from achieving the specific emission level
• Max B(e) -C(e)

dB/de-dC/de=0 => Marginal damages = Marginal abatment costs

Question 8

What is the Kaldor-hicks efficiency?

Answer 8

Potential Pareto-efficiency

An outcome is considered more efficient if a Pareto optimal outcome can (but does not necessarily have to) be reached by arranging sufficient compensation from those that are made better off to those that are made worse off so that all would end up no worse off than before.

Question 9

How are we distributing allocations today? is it an efficient decentralized market system?

Answer 9

• We are in a world mostly driven by free market allocation.
• Markets just bring buyers and sellers together and relevant information is only needed to be known by buyers and sellers
• -> This can work efficiently and socially optimal when we assume:
  
  1. -Markets exist for all goods and services in economy (environmental services?)
  2. All markets are perfectly competitive
  3. There exist perfect information (everybody knows everything)
  4. Property rights are assigned to all resources and commodities
  5. No externalities or public goods
  6. All “well behaved” (firms profit maximize and consumer utility maximize)

Question 10

Market failure, why?
externalities, why do externalities create market inefficiencies?

Answer 10

Because we need a fucking perfect world to achieve free markets:

• Strong assumptions needed for the market system to be efficient and socially optimal, and it fails because of these three reasons:
• Public goods:
  
  • ​A pure public good: is non-rivalrous and non-excludable e.g. defense, lighthouses, street lighting
  1. Rivalrous and non-excludable: Open access fisheries –> tragedy of the commons
• Non-rivalrous and excludable:* national parks (up to a congestion threshold)
• Externalities
• Information asymmetry (moral hazard and adverse selection)

Question 11

How do public goods affect efficiency, explain the incentive problem of public goods?

Answer 11

1. In a market economy, pure public goods are never produced: –> no incentive for private supply even if public demand exists, so –> Other institutional arrangements have to be set up to provide public goods, i.e. governments!
   - -> no supply
2. Free-riding Behavior: Everyone profits from public goods even if he or she does not contribute to the production costs
   - -> high demand
3. Collectively optimal (efficient) solution and individually optimal behavior diverge (Prisoners‘ Dilemma)

Question 12

Snowdrift game

Answer 12

It is the environmental perspective to the prisoner’s dilemma

Where exploiting while the opponent does not participate results in a positive pay-off

Question 13

What is an externality?

Answer 13

“An externality is present whenever some individual’s utility or production relationships include real variables, whose values are chosen by others. . . without particular attention to the effects on that person’s welfare.” (Baumoland Oates, 1988)
•Important points:
⇒Real variables -a shift in production/consumption possibilities
⇒Externality is produced without consideration for others
⇒No compensation to victim or beneficiary of externality

Question 14

what type of externalities are there?

Answer 14

Positive vs negative

•Positive (external benefit)e.g. Vaccinations protect against disease for individual but also help prevent the spread of the disease too -benefit to wider society
•Negative (external cost), e.g. pollution
–> Again note that in both cases, no compensation or payment exists between the two parties

public vs private
•Externalities can be either public or private goods
•Most likely they are public goods (assumption in this course).

Question 15

Why do externalities create inefficiencies in markets?

Answer 15

• Costs/Benefits of externalities are not borne by decision-makers so therefore not taken into account when decisions are made.
• Externalities causes allocative inefficiency
  
  • ⇒Positive externality -not enough externality is produced compared to the allocative efficient outcome
    ⇒Negative externality -too much externality is produced compared to the efficient outcome

Question 16

How is Climate change an externality?

Answer 16

• Climate change or the accumulation of GHG is a negative externality on all citizens of the world
• Agents choose actions such as driving cars, producing goods which produce pollution as a by-product
• Pollution being emitted compared to the allocative efficient outcome. (Graphed in next lecture)
• The effect of GHG is a public “bad” (good).