Atanu Dey On India's Development

An economics moment

This is a personal post. Not exactly what I had for breakfast type of post but close.

I clearly remember the moment when a light went off in my head. Brian Wright was teaching and we were talking about EV and CV. Equivalent variation and compensating variation, and the related concepts of “willingness to pay” and “willingness to accept.” As I had come to economics rather late in life, I had had the opportunity to figure out some of the basic concepts in my head. But I did not have the vocabulary to fully express the ideas. So when I got the vocabulary, it was an “aha” moment.

I remember Brian posing the question: so PG&E (the local gas and electricity utility company) is going to string up high-tension cables above your backyard. You know that that increases health risks. In economics terms, negative externalities accompany this action. That raises two questions.

  • How much are you willing to pay to stop PG&E from doing so?
  • And how much are you willing to accept to allow PG&E to do so?

Note that in the former case, the assumption is that PG&E have the right to string high-tension cables over your backyard and you wish to stop them; in the latter case, you have the right and can disallow PG&E from stringing wires across your backyard. It’s a matter of who owns the rights.

The willingness to pay is bounded by how deep your pockets are but the willingness to accept is open-ended. If PG&E owns the rights,then most likely you are out of luck because you will not be able to pay them enough to deter them from going ahead. If you own the rights, then you can make a pretty neat pile of cash by holding out.

Ronald Coase showed that regardless of who owns the property rights, if there are no transaction costs, then bargaining among the parties is sufficient for the discovery of the economically efficient amount of pollution.

Sometimes I wonder. I wonder if we would continue to have the kind of problems such as Nandigram if basic economics principles were better appreciated by a large percentage of the population. I think a lot of coercion and violence could be avoided. But perhaps I place too much faith in rationality.

  • http://www.cse.iitb.ac.in/~parijat parijatgarg

    Way too much faith.

    Against logic there is no armor like ignorance.

  • http://chaitanya1.wordpress.com chaitanya

    Hi Atanu,

    This post is anything but what-i-had-for-breakfast types :) Seems to me it has some pretty important concepts related to environmental economics.

    Lets take a concrete example — Building a hydro dam which has all the well known benefits, but also involves displacing people and submerging some amount of dense forest.

    The economist view would be:

    >>> … bargaining among the parties is sufficient for the discovery of the economically efficient amount of pollution.

    couple of points:

    (1) The “parties” mentioned here are obviously people on both sides .. the affected forest people on one side and the government on the other. The forest and its inhabitant species wouldn’t have any bargaining chips. So, this is people’s version of an economically acceptable solution. (Anthropocentric solution, if we were to use the technical term).

    The social externality has been taken care of through the bargaining process, but environment externality has been left out. (All the services that the forest would provide would be affected).

    (2) The economist might say — ok, lets quantify the environmental impact as well. Calculate the value of all the ecosystem services that the forest provides, and try to internalize this cost. (a) See if the cost exceeds the benefit from the project .. so shelve the project ? (b) Try to replicate the services in another place, by tree plantation etc. Something like .. Rob peter to pay paul.

    Whatever be the approach to internalize the cost, the very fact that we put a price on an environment means that we are taking a utilitarian view.

    Anyway, the point of my post is .. environmental economics might claim to internalize the environmental costs, and somehow arrive at optimum level of pollution. While env-econ approach may sound scientific and objective , i think it leaves the underlying value assumptions open for debate — Anthropocentric, utilitarian world view. Iam not arguing for-or-against these worldviews here, but just recognizing that these are unanswered by conventional env-econ.

    would really appreciate any comments.

  • http://www.deeshaa.org Atanu Dey

    Chaitanya:

    I mentioned the Coase theorem. It is worth looking at. Note specifically the phrase “if there are no transaction costs” — which in the real world does not obtain. A full treatment of the Coase theorem is outside the scope of this comment. But if you do, you will see “no externalities.”

    So what good does the theorem do? It’s a starting point on how to think about matters of negotiations and bargaining, of property rights, of the importance of transaction costs, and under what circumstances are efficient outcomes obtained through market processes and under what circumstances does non-market levers work.

  • Amit

    Sometimes I wonder. I wonder if we would continue to have the kind of problems such as Nandigram if basic economics principles were better appreciated by a large percentage of the population. I think a lot of coercion and violence could be avoided. But perhaps I place too much faith in rationality.

    Probably. I wonder how rational is it to not take into account the fact that others may not think in a rational manner, or even those who do think rationally, may have disagreements or different interests, and not behave rationally. IMO.

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