Economics of Complex Systems: ValueAdded Knowledge

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Economics of Complex Systems Value-Added
Knowledge

• Kathleen Segerson
• Department of Economics
• University of Connecticut

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• Economics ? commercial viability
• (cost of production, marketability)

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• Economics
• study of allocating scarce resources among
  competing ends
• study of making decisions

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Thinking like an EconomistKey Economic
Principles/Concepts

• Explanation/Prediction vs. Evaluation
• Tradeoffs
• Optimization
• Behavior
• Incentives
• Prices and markets
• Externalities
• Economic efficiency

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Explanation/Prediction vs. Evaluation

• Explanation/Prediction of behavior
• How do people make decisions about.?
• What would be the impact of ?
• Micro vs. macro-level analysis
• Evaluation (of outcomes/policies)
• Criteria for ranking?
• Economic efficiency
• Distributional considerations
• Importance of behavioral responses

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Focus on Tradeoffs More of one thing means less
of something else

• Types of tradeoffs
• Tradeoffs we have to make (based on technological
  feasibility or resource constraints) ? costs
• Tradeoffs we are willing to make (based on human
  values and likes/dislikes) ? benefits
• Can be for individuals or society as a whole

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Tradeoffs ? benefits and costs

• Important distinctions
• Who bears costs and benefits?
• Private vs. social costs/benefits
• Economic costs vs. engineering/accounting costs
• Economic benefits vs. commercial benefits vs.
  impacts

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Who bears costs and benefits?

• Internalized benefits and costs
• Intra-generational distribution (e.g., new
  technology can benefit some at expense of others)
• Inter-generational distribution (e.g., new
  technology can benefit one generation at expense
  of another generation)

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Private vs. Social Costs/Benefits

• Examples
• Redistributive taxes
• Price paid for a carbon allowance
• Externalities

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Concept of economic cost

• Economic cost opportunity cost what is
  given up to get something
• Examples opportunity cost of time
• cost of a dam
• Irrelevance of sunk costs

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Concept of economic benefits

• Benefit what you would be willing to give up to
  get more of something (willingness to pay)
• Can apply to a market or non-market good or
  service (e.g., environmental quality, species
  preservation)
• Basic concept
• U(Income,Q1)U(Income-WTP,Q2)

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Benefits ? Impacts

• Examples
• Tax revenue
• Jobs
• More jobs isnt always better (e.g., low
  productivity)
• Projects that create jobs dont necessarily
  generate economic benefits (e.g., cleanup of
  spill)
• Technologies that displace jobs dont necessarily
  involve negative benefits (costs)

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Valuing outputs vs. inputs

• Technology/production function yf(K,L,R)
• Inputs (K,L,R) ? Output (y)
• Revenue from sale of output ? payments to inputs
  (dividend, wages, payments to suppliers, taxes)

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Benefits as cost savings

• When output is the same, benefit can be measured
  as reduction in cost of producing that output
• e.g., benefit of trade part of cap-and-trade

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Economic approach to human decisions optimization

• Basic premise people make choices to maximize
  their well-being (broadly defined) ? they respond
  to benefits and costs
• Optimization ? Balancing and the Marginal
  principle choose X where
• marginal benefit marginal cost

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Behavior Matters

• Need to consider behavioral responses
  (adaptation) when
• Predicting outcomes
• Measuring benefits and costs
• Example Effect of climate change on
  agricultural output
• yf(T,x), but xx(T)

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Behavior responds to incentives

• Two types of incentives
• Positive Increase (marginal) benefit
• Negative Increase (marginal) cost
• Link to unintended consequences
• Important tool for changing outcomes
• Link to technological fixes?
• Alternative solution?
• Adoption incentives?

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Prices and Markets

• Prices create incentives
• High price ?
• Incentive to consume less
• Incentive to produce more
• Low price ?
• Incentive to consume more
• Incentive to produce less
• Prices are established through
• Markets (supply demand)
• Policies (e.g., carbon tax)

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Externalities

• Actions of one party (e.g., individual or firm)
  unintentionally harm (or benefit) another
• Problem Lack of price/market for some good or
  service
• Example Clean Air
• Unpriced input ? consume too much
• Unpriced output ? produce too little

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Economic Efficiency

• Efficiency getting the most out of available
  resources
• maximizing net benefits to society as a whole
• Balancing of benefits and costs
• Result Can think, e.g., about an efficient
  amount of pollution

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Applying principles to complex systemsLinked
human/environmental systems

• Basic principles hold, but it can be very
  difficult to
• Predict behavioral responses
• Measure benefits and costs

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Example Biofuels

• Problem Dependence on foreign oil and GHG
  emissions from fossil fuels
• Solution Increased use of biofuels
• Questions
• Effect of policies to promote corn-based ethanol?
• Could effects have been anticipated with a more
  holistic approach?

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• Policy ? increased demand for corn for ethanol ?
  price of corn (all uses)
• ? increase price of grains ? increase food prices
• ? switch land from soybeans to corn ? decrease
  supply of soybeans ? increase price of soybeans ?
  increase food prices
• ? increase land in corn production ? increase use
  of fertilizer ? increase runoff, e.g., into
  Mississippi River and Gulf of Mexico ? increase
  hypoxia zone in Gulf ? impact on shrimp (?) or
  other impacts
• ? clearing of carbon-rich habitats (e.g.,
  rainforests in Brazil, or land in CRP) (?) to
  produce more corn ? net increase in GHG emissions
  (?)