Chapter 15: Distribution May 20, 2009

Pareto optimality Economics defines efficiency as the Pareto optimal allocation of resources by the market  Assumption?  Efficient allocation = best satisfies individual wants weighted by the individual’s ability to pay (by income and wealth) Issue of distributive equality is avoided Economics assumes certain cultural values  (1) objective efficiency  (2) redistribution efficiency not considered

Distribution of income and wealth Wealth = stock of assets, measured at a point in time (eg?) Income = flow of earnings from these assets + earnings of your own labor power (or human capital) over a period of time  Income and wealth: two different magnitudes, measured in different units, and distributed differently over the population (eg: $ vs $/time)  Wealth: usually more concentrated than income; financial wealth even more concentrated Why the distribution of wealth among individuals?  Historical result of whose ancestors got there first + individual ability and effort + luck

Measuring distribution Lorenz curve: plots the % of total income going to each % of income recipient (income on the Y axis, and income recipients on the X axis) The closer the curve to the 45-degree line, the more equal the distribution; the farther away, the less equal. The shaded area (between the curve and the line) measures inequality Gini coefficient: ratio of the shaded area to the total triangular area under the 45-degree line; used to measure the inequality of the distribution of wealth or income across a population Gini coefficient of 1 = perfect inequality; coefficient of 0 = equal distribution Also concerned with wealth and income *between* countries and not only *within* countries

Measuring distribution Is there a legitimate range of inequality, beyond which further inequality becomes either unfair or dysfunctional? What do *you* think?  Plato: richest citizen should be 4 X wealthier than the poorest Ecological economics: since real total output cannot grow forever, then the total is limited, then the maximum for one person is implicitly limited Functional distribution of income: What about paying for nature’s contribution? Who would collect?

Consequences of distribution for community and health Inequality of income distribution has a substantial effect on rates of death and sickness – regardless of the absolute level of income of the poor. How?  Less control over the circumstances of your life  Greater risk of job loss  Lower level of social standing and respect  More frequent experiences of disrespect and shame  More threatening life – and the threat comes from those above the hierarchy  Indirect social effects on health (see Table 13.1)

Intertemporal Distribution of Wealth What about the distribution of resources between generations and not only within a generation? Should we try to make the future better off than the present? Do we have an obligation to make sure it is not worse off than the present? 2 alternative approaches  ecological economics approach – based on ethical judgments concerning obligations to future generations (intergenerational justice)  more mainstream economics approach – based on an ‘objective’ decision-making rule (intergenerational allocation)

The normative approach of ecological economics Since you didn’t choose to be born in this generation, there is no moral justification for claiming your generation has more right than another Therefore: future generations have an inalienable right to sufficient resources to provide a satisfactory quality of life, and we have a corresponding duty to preserve an adequate amount of resources What is adequate? Depends on technological and ecological change. Both characterized by ignorance. Ethical decisions affect our actions. Practically, what does this mean?

The ‘positive’ approach of neoclassical economics Not an ethical problem, but a technical problem. How? Comparing future benefits and costs w/ those that occur in the present. How? Intertemporal discounting -> valuing the future less than the present; people preferring things now rather in the future. Why? (1) impatience -> pure time rate of preference (2) opportunity cost -> if money is fungible, then it gets more weight to any resource today than the same resource tomorrow (3) expectation of future riches -> richer future argument Net present value: what present and future costs and benefits are worth to us today. Implication? Box 15-2

The ‘positive’ approach of neoclassical economics: discounting reconsidered Intertemporal discounting: makes sense for the individual and for market goods. Does it make sense for society and for nonmarket goods? How are societies different than individuals?  Immortal (relatively) -> therefore, all economists agree that social discount rates < individual discount rates  Social discount rates: rate of conversion of future value to present value that reflects society’s collective ethical judgement as opposed to an individualistic judgment  No agreement on opportunity cost of capital…

The ‘positive’ approach of neoclassical economics: opportunity cost of capital Financial capital: we can invest it if we have it now. But a social discount rate into the indefinite future may be inappropriate because (1) the real value of $ can only grow if the production of goods and services that $ can acquire also grows. What is the problem here? (2) many investments are ‘profitable’ because we ignore many of the costs of production (2b) if we consider that natural capital must be treated separately from manmade capital (why?) then the decline in natural capital + law of diminishing marginal utility -> negative discount rate to natural capital, or positive discount rate only to highly fungible goods and services (3) only finite opportunities for productive investment in an economy (4) technology – at best – can complement resources and can never replace them

So – what can we say about discount rates? Make sense for individuals – in the short run, and for some small-scale, short-term social projects Intertemporal allocation: apportionment of resources across different stages in the lifetimes of basically the same set of people (same generation) Intertemporal distribution: apportioning of resources across different generations Distribution is different from allocation  therefore – justice replaces efficiency as the criterion for policy when time periods become intergenerational

Big Ideas to Remember Pareto optimality Role of scale and distribution in defining Pareto optimal allocation Income distribution vs. wealth distribution Functional vs. personal distribution Social limits to range of inequality Lorenz curve Gini coefficient Inequality and health Intertemporal distribution vs. intertemporal allocation Discounting and net present value Pure time rate of preference Individual vs. social discount rate

Exam: May 22nd Material on the exam  Environmental Economics Chapters 6, 7, 8, 13,  Ecological Economics Chapters 10 and 15  GDAE  Extra reading Including Chapter 13 in Ecological Economics Including material in Valuing Earth