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Module 1: Renewable and Non-Renewable Economics Resources

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Preferences and Social Choice

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We have looked at the resources. We have also looked at a model by which we can identify how the non-renewable resources would get utilized. We have just finished the Hotelling model. We now switch tracks, we are going to now move into Environmental Economics and we are going to look at how to do we tradeoff between energy, development and environment. Before we do this, we need to understand some basics of demand and we will talk about preferences and utility. So, we will introduce some simple conceptswhere we talk about preferences and utility. (Refer Slide Time: 01:05) Now, in general, in life, we are always encountering choices and we have in these choices we always have preferences. So, when we talk in terms of economics, we would like to quantify these preferences. So, we would like to rank the preferences between bundles of goods and services so, to simplify things, we will look at two goods, x and y and we are talking of goods but it could be goods and bad, that means it could be pollution, it could be garbage, but in general let us look at if we are talking of two goods x and y, how do we choose between those goods and then we want to understand consumer choices and preferences. This is a whole field in itself but we are just going to look at the basics of it and use it and quantify it and then use it to see how we can make tradeoffs between different choices. So, we look at its start with first looking at individual choices, and then we will come to when we aggregate these individual choices into a societal choice. So for simplicity, let us look at two goods x and y, these goods could be wine and cheese, that is the examples which is taken in the book by Kolstad on Environmental Economics, pizzas and movies you will see if you look at different kinds of lectures which are available, people are talking about pizzas and movies and sometimes when you have a fixed amount of money, which you want to spend and you want to enjoy a movie or you want to see the movies or you want to have pizza or do you want to do both, and we look at that. And similarly, we take these two goods as things that we can relate to, but we can translate that finally to resources, energy use and environment. In the case of preference relation, we have some properties. (Refer Slide Time: 03:19) The first property is that there is a completeness that means each individual knows his or her preference between a different set of goods. At most one can say that we are indifferent, these two are equivalent, otherwise, I prefer this to that or I prefer the other one and so on. So, it is not that we to be left ambiguous that is in terms of completeness of the choices. Then the second is that there is transitivity we have, that means the preferences are rational. (Refer Slide Time: 03:54) For instance, we create a suppose we say that you prefer, suppose I prefer apples to oranges. So, this symbol which says apple is preferred to orange and suppose orange is preferred to bananas. If the preference is rational then it will be transitive, that means if A is preferred to B and B is preferred to C then A is preferred to C which means that apple would be preferred to the banana. So, this is the second part we talked about completeness we talked about transitivity. The third assumption for preference relation, the property is non-satiation and this is not always correct assumption in real cases, but for the economic calculation, we say that more is better. That means if you have if you watch two movies it is preferred to watching one movie. If you are having two pizza better than one pizza and so on. So, that the idea is that it is monotonicity, there is no satiation in actual practice, you know that after a point you stop, you do not have any hunger and you would not want to. So, there would be satiation but for all the in the economic utility context, we talk of non-satiation. (Refer Slide Time: 05:46) So, in the preference relations which we have, now we have the following possibilities. We had this sign where we talked about x preferred to y, this is a strict preference that means x is always preferred to y and the weak preference is where x is preferred to or equivalent to y this is a weak preference and x this is an indifference relation which means that the consumer feels x and y are equivalent and this is called indifference. (Refer Slide Time: 06:33) So, with this we would like to introduce this concept of, we talked about transitivity and non-satiation, we would like to look at these preferences. (Refer Slide Time: 06:41) So for instance, if we look at them, if you are talking of 3 points, in the case of A you have 1 movie and 2 pizzas, here we have 2 movies and 1 pizza and C is where you have 2 movies and 2 pizzas. As per the non-satiation, C would be preferred to B and C would be preferred to A. Between A and B, we have to then decide it will depend on the individual. And suppose, both are equivalent for the indieual, then we can say that A and B we are indifferent to this, we can join a set of all points where which are equivalent to us and that is called the indifference curve. Of course, here we are talking of discrete values, but in general, we can look at a continuous kind of curve. (Refer Slide Time: 07:48)And this is the indifference curve is a set of consumption bundles that the consumer think are equally good. She or he is indifferent to the consumption bundles that means if you have consumption bundle X indifferent to Y, this set of these points is provided by an indifference curve and this X could have a whole set of different goods and Y could have another set of different goods. Of course, we are looking at initially just looking at to simplify things, we are looking at two different goods and the combinations of that. (Refer Slide Time: 08:34) So, for instance in that example that we talked of in pizzas and movies, if you said that 2, 1 and 1, 2 are equivalent, then we have an indifference curve here and this with 2-2 is on a different curve and the utility or the value that I get from this is higher than the value that I get from this. So, this is based on the fact that there is non-satiation, so, the utility is a mathematical way to represent the value that the consumer assigns to a particular good or a bundle of goods and services and this the indifferent curve represents a locus of constant utility. And so, this is utility is equal to constant this is, and the utility increases in this direction so, this is the basic way in which we represent consumer choices. And let us look at some of the characteristics of these indifference curves. So, let us look at this whether or not it is possible for two indifference curves to intersect, based on our initial principles, if you said all the points on this indifference curve will have the same amount of utility and all points on this indifference curve will have the same utility. So, which means that if we take the point which is intersecting that is X and compare that with Y these would have the same value of utility. On the other hand, if we compare that with Z, Z will also have the same value of utility as X. But if you look at these two points, Y based on non-satiation the value of utility at Y is greater than that at Z, which means that we have violated this. So, the indifference curves will not intersect, they will be, in general, they will be parallel to each other, they will intersect. So, this is not possible. (Refer Slide Time: 10:42) The other thing is that, is it possible, let us look at this, it is not possible to have an upward sloping indifference curve, again this goes based on the fact that we have the non-satiation, also it is not possible to have a thick indifference curve. (Refer Slide Time: 10:58) So, how we will have in general utility shape of the indifference curve would be such that it would be convex, which means that instead of having a combination of two goods and services will have higher utility than the individual amounts of goods and services. So, this is the characteristic of convexity. (Refer Slide Time: 11:25) Let us now define what is utility? The utility is an economic term referring to the total satisfaction received from consuming a good or service. In many cases, we try to quantify some of these things by money, but in general, we are looking at it as an expression by which we look at the satisfaction received from consuming a good or service. So, if we, what is the utility that we have by consuming an apple or consuming an orange and we said this is dependent on the preferences, this is dependent the individuals choice and when we have this and we can quantify it, then we can look at two different individuals, their choices and look at the utilities which are obtained. So, in general, the utility is a function of the amount of consumption, it is a mathematical representation of a preference relation. There are many different possible utility functions and in the tutorial will give you these you can cross-check, whether these are convex and whether they can represent the utility functions. And you can see these are some of the functions which are there and which have been used in literature, in mapping some of the utility. (Refer Slide Time: 12:44) What are the properties of the utility functions? So, the first one is independence, the utility is dependent only on the choice between those goods. Completeness, we said that,yes, it maps the entire range of choices. Transitivity, we saw the transitivity of the preferences and now transitivity is, therefore, the utility function. Continuity and there is an, it is an increasing function with u dash x greater than 0. The other point which is to be remembered is that in general, in principle we consider them as ordinal not cardinal that means we rank our preferences, we say that an apple is better than an orange or is preferred to an orange, but we do not say we will not like to say then an apple is 50 per cent more than orange so, we do not convert it into that kind of thing. But in many cases, when you look at the kind of calculations is done this assumption is often relaxed. (Refer Slide Time: 14:01) So with the result that you create something like a utility function we want to also now calculate the change in utility per unit of additional goods. So, that means we can look at what is del u by del x. And if you look at the change in utility per unit of additional good, the question is should this increase, decrease or remain constant? Think about any context and you can understand how this will change and there is this law of diminishing marginal utility. (Refer Slide Time: 14:36) And that if you see, so for instance, there is this example which is given by Serrano and Feldman, where we are looking at and there is a rich tourist who is stranded in a desert, it is hypothetical context and there is a monopolist who has bottles of water and the tourist has 100 units of money available with her and we see that you are thirsty so, for the first bottle of water, you are willing to pay a significant amount, that means 25 units. For the second bottle, you are willing to pay less for the third bottle even less and so on till the point so, basically what happens is for every additional good that we have, we are actually, the utility of that good diminishes. So, del u by del x decreases as it goes, as you go ahead and so this is the law of diminishing marginal utility. And we can also then see what happens if we talk about two goods and we have a utility function of these goods. (Refer Slide Time: 15:58) We have this curve where we are shown x or let us put this as y and x and you have U as a function of x y, we have U, we want that we have a fixed amount of resources. That means for x, there is a price of x and there is a price of y and there is a final budget that we have. So, we can say that we want to maximize the utility that we have, maximize U as a function of x, y subject to the total amount that we are willing to spend on both these goods. So you may have a budget on each of these, we can say that let us say Px into x, Py into y less than or equal to B. So, we want to maximize U x,y subject to the budget, the total expenditure on x and y should be less than the budget that we have.(Refer Slide Time: 17:13) If we take that then we can create again the Lagrangian, which will be U XY plus lambda B minus Pxx. So, if we look at this we can differentiate this and what would we get? We would get del U by del x minus lambda Px equal to 0 by del y, del U by del y lambda Py is equal to 0. So, we can write this as lambda is equal to del U by del x by Px lambda is also equal to del U by del y by Py. If we equate this, what would we get? We get and you can see this essentially what you will get is del U by del x by del U by del y is Px by Py. (Refer Slide Time: 19:41) And this is essentially giving us the marginal rate of substitution and the marginal rate of substitution is the how much of x which we will marginal rate of substitution when we look at if we move on the utility curve and we have a change where the utility remains constant then this gets minus delta x2 by delta x1 and this will be marginal utility of 1 by marginal utility of 2, this is going to be equal to del U by del x1, by del U by del x2. (Refer Slide Time: 20:31) So, this is the marginal rate of substitution, in the equation, in the utility curve that we had we get x y, then we had the utility curve, what we found concerning the budget constraint is that you would have a line which is tangential to the utility curve, which is maximized and with the slope which is the ratio of the prices and this will give us the optimum point. And then with this now we can see that what happens if the prices change, what happens with the utility changes. And in the tutorials will take a few examples where we can look at this, you can look at. Of course, in the case of the indifference curve, we can also look at indifference between environment and resources and this is what we will go to. (Refer Slide Time: 21:25) There are several different resources that you can use for this section. nd you can look at the any of these, there is a book by Kolstad there are some lecture notes in the open coursework, in MIT and then the lecture notes in Serrano and Feldman. And this will give you an idea of preferences and utility. We will next look at when we want to take these preferences and we want to aggregate these preferences and we want to look at societal choices and societal choices betweenenvironment and energy and resources and economics and we will link this all up in the next section. Before we do that, we are going to look at the philosophical basis by which we make decisions. So, we will take a look at the different kinds of ways in which we can take philosophical decisions related to the environment, what are the kind of choices which are there, then we will look at the Kenneth Arrows theory of social choice. So far we have talked about individual preferences and for an individual choice between two goods, and then we represented it in terms of preference and then an indifference curve and then looked at utilities and looked at substitution. We are now extending this to the real world. We want to look at when you have a society of several individuals, how does society make choices and specifically we are interested in choices which relate to environment and development. So, you may want to look at, there is a good textbook by Kolstad, Charles Kolstad on Environmental Economics, some of this material is based on that. So, we want to ask the following questions in environmental policy, what is the right balance between environmental protection and use? How much of environmental protection should we have? And this question is not an easy question to answer. It is a social and political question. We will see in concept, how do we aggregate and how do we translate the individual preferences into something which results in a group or a societal choice. (Refer Slide Time: 01:44) So, to do that, we will first start with some of the, let us look at some of the kind of choices that we have. So, in Kolstad's book, he talks about three examples of environmental choices. The first example is from Chile, a city in Chile, Santiago. Santiago is one of the busiest cities in Chile in Latin America, and it has a severe air pollution problem. And most a lot of this problem is happening based on diesel private vehicles, as well as diesel buses. And there are many different possibilities, the buses are used by the poor and they have relatively low prices, there are in Chile, like many of the developing countries, it is a, there is a significant amount of inequality. So there is a small proportion of the population which is rich and the rich population is more concerned about the air pollution than the poor, the poor are concerned over much more immediate concerns but the health impact happens to everyone who stays in the city. And so the question is, how much investment should the city do in terms of pollution control, can it modernize its bus fleet, if it modernizes its bus fleet, the cost of public transport and the fares may increase, it may not be affordable for many of the poor to travel in the bus. And so this is one of the choices that are there. It is a very clear choice in terms of air quality, environmental damage, and then the kind of value and the value proposition and the price. The second example, that Kolstad talks about is an endangered species. It is a small bird, the California Gnatcatcher, which is located in one area of Southern California and this is also an area, the area around it is an area, which is highly industrialized. There is a lot of business and there is a possibility of using that space for development. However, that is the habitat of the California Gnatcatcher and the question is that should it be declared as a protected area with the result that of course, it will affect the local community in terms of that area will not be available for building up and for development. However, the species will be preserved and then the environmentalists as well as the individuals who are interested in preserving the species, the ecosystem from that point of view, that this would be beneficial. But the question is, who are the stakeholders in this case? Is it only the people who live in that area, is it the people who visit, is it the people from the entire state of California? And so there are questions in terms of who are the stakeholders, what kind of matrix, what are the kind of tradeoffs? The third example that Kolstad gives is the largest electricity dam project in the world. It is a Three Gorges Dam in China, which is on the large scale, at the Gigawatt scale. The reservoir is 500 kilometres in length. It had a lot of opposition initially, but the Chinese government went ahead and built it, there is a large, it is on the Yangtze River, there is a large amount of land which has been damned. The benefits of this will go for the electricity generation, as well as the development of the country. In terms of losses, it means that the local population gets resettled and then there are several other issues because of this large dam of water. And these kind of issues globally are affecting almost all large hydro projects and in many countries, this has resulted in severe delays and sometimes even cancellation of some of these projects. To take this back to now, let us look at a few examples from India, the Narmada Valley project. (Refer Slide Time: 06:34) Now, if you look at the Narmada Valley project, and you will find that this is one of the largest hydroelectric projects, both for electricity as well as for irrigation in the country, it involved the whole set of different states. There are states downstream and upstream and the benefits accrue to a set of farmers and a set of regions and the losses are occurring to people who are in the project affected zone. There was a very strong movement called the Narmada Bachao Andolan, and there were several court cases, the heights of the dam were reduced and overall the project was delayed significantly by several years which resulted in cost overruns. Now, depending on the kind of literature that you see, you are either for the project or you are against the project. And it almost seems like there two different stories. But when you look at projects like this, this is where there is this choice of development and environment. How do you assess, how do you decide to make a social choice and what are the kind of ways in which you can do that? There is a project in Kerala, the Pathrakadavu hydroelectric project and this was very near the Silent Valley. And this is the habitat of the Lion-tailed Macaque, which is a particular monkey, which is available whose habitat is in that region. And the opposition to this project was that this will affect their habitat and it would affect the biodiversity. The project went through several iterations and was stalled and again, I think it has been revived, it is not yet, we are not yet clear about what is the final status on this. The third example that I give you, is an example that you will find very interesting but it is unique in its context. So, one of the largest companies in the world Vedanta has been mining bauxite for when you look at aluminium and you have aluminium refining and bauxite mining, they wanted to extend this to the Niyamgiri hills in Orissa and the Niyamgiri hills were one of the few habitats where there are tribals who, the protection of the hills and the habitat, and the trees in those hills have a religious value to them. And so there were several NGOs who are opposing it, locals and there was a standoff between the project proponents and the project opposer. And this is where the courts got involved and finally, this was the one example in which it was decided by the ministry and the courts that the residents, the villages who were affected in these hills, there would be an election. And the project was to be decided, there will be voting on whether the project would be a yes or a no. And it would be done at each Gram Panchayat level. Observers were coming in, this is widely reported and there are videos and newspaper reports, you can read about it. The first time this was done for an environmental project and interestingly every village rejected this proposal, and with the result that this bauxite mining proposal was installed. So this was an interesting kind of example. Iron ore mining in Goa has become a sort of political issue. The mines were closed and then so because of environmental damage and land use and so, again this is another open kind of issue, the advantage any mine or any industry that you talk off will create jobs, will create development, but on the flip side is that it will have an impact on the land use, it will have an impact on the environment and we have to make tradeoffs between this. In Mumbai there is a large coastal road project going all the way to South Mumbai and again this is a heavy investment and this had been this again has had several opponents and I believe that with the change in government, this may again be reviewed. The most cities in India now are going in for expansion of public transport with metros and metros, of course, are that way environmental friendly because they are reducing the local emission, they are reducing the congestion as well as the CO2 emissions. For the metros, whenever you have the metros, you will have to have locations where the metros will be parked and that means there are sheds which will take a reasonable amount of land area, in a city like Mumbai, you do not have large tracks of land which are still not, which is still available, the metro shared is planned Aarey and Aarey colony is one of the few green patches in the city. And so there have been, there has been opposition to the metro shed in Aarey, there were protests and there was this case, Supreme Court case. Some trees were chopped down and this was an issue in the elections, and subsequently, this is again going to be reviewed with the change of government. So, as you see, these are some of the examples which illustrate to you that there are many different aspects when we look at many of these projects. There is always this tradeoff that we think in terms of when we look at the development and the environment. So, we will try and see how we analyze this, what are the kind of ways in which we can look at the framework that we have talked of in terms of utility and look at individual choices and comparing individual choices with this. Before we do this, we need to understand what are the perspectives or the individual beliefs based on which we are going to do the analysis. So you can read up about most of these projects. If you just Google them you will get details. (Refer Slide Time: 14:03) So, this is, for instance, the Pathrakadavu Hydroelectric Project, some details that I get from the public domain in terms of the review, if you see this, the 70-megawatt project cost of about 420 crores, similarly, you can look at the technical details as well as the environmental impact, most of these projects would have some environmental impact assessment.