Aryaman · I wasn't

HS 200

Module 1 - Economic Aspect

Lecture 1 (2nd March 2020)

  • In ES 200, we were introduced to the ecological and health aspects.
  • In HS 200, we look at the the philosophical/social aspects.
  • Note: Next Monday, 9th March is a holiday
  • Three components:
    • Economics
    • Social
    • Philosophical
  • We’ll have only one end-semester exam → April. Fifty mark exam, ninety minutes. Completely objective type. Multiple choice, T/F, FIB.
    • Approximately same weight-age for all parts. 17 + 17 + 16 in some order.
    • Questions from slides, classroom discussion, reading material uploaded on Moodle. For social part → short videos will be shown. Questions based on those videos as well.

Some concerns:

  • Global warming → ice caps melting → coastal cities are in danger. We keep hearing news about “xyz city will be underwater by 20XY.”
    • It is a fact that ocean levels are rising.
  • CFCs bad. Plastic in water.
    • Prof read in paper: “Sample testing conducted in India. The salt we have contains a large number of micro-plastics.” Bad for health.
  • Landfills → cause degradation to soil quality.
  • We also have resource depletion:
    • Deforestation. E.g., Amazon fires
    • Overfishing

Now we see economic concepts to understand the problems.

  1. Externality: In particular, negative externality.
    We know that dumping stuff in rivers is bad. Why do factories still do it then? Why are the authorities not being able to stop these issues?
  2. Free Rider Problem: Pertaining to public goods. (Not private.)
    Public goods: People tend to utilise it in a bad way/carelessly as compared to if it were a private good. (Prof might even throw in some Game Theory.)
  3. “Cake-eating problem” → something in macro eco. Essentially a dynamic programming problem. Want to maximise something which is changing dynamically. You have a cake, how much do you eat it everyday to maximise happiness?
    Suppose you have a forest. How much of the trees will you cut down?
    If you cut all, then gone. If you leave some, it can regrow.
    The theme: What you save today, you use as capital tomorrow.
    Saving stuff: gives more for tomorrow
    Consumption: gives happiness now :)
    Economists have been seen to be more worried about consumption.
    If you offer someone 100 for either today or tomorrow, they’ll take it today. To convince them to take it tomorrow, you must offer something strictly greater for tomorrow.
    That’s how a fixed deposit works.
    If you don’t think about tomorrow, you take more than the resources are there.
    Examples: Overfishing. Hilsa fish in Bangladesh. Very popular, almost went extinct due to fishermen. Government stepped in and has stopped fishing for 7-8 months. This was a public good.
    Everyone thinks: “If I don’t catch it, someone else will. So, what’s the point? I’ll only fish.” A sort of prisoner’s dilemma. The better option would be that no one fishes. But that does not happen. (Nash equilibrium.) → Coordination issue

What is needed?

  • Write some function that maximises not only current profit but also future. Could be an infinite time horizon → “overlapping generation models.” You get requests from your “parents” and leave requests for your “children.” Times T-1 and T+1 are also considered.
  • Economics and environments are interlinked now → Has been noticed that economic incentives make people work. You may educate people however you want but they (most) won’t care a lot unless you give money.
    • Might subsidise companies who use cleaner methods. E.g., organic instead of harmful pesticides.

Interdisciplinary

  • The course deals with the economic aspect → incentivise people. Socio-psychological aspects → “behavioural economics”. warm-glow effect/altruism: do something good for society/charity, it gives you a fillup. (Utility is increased.) This was never considered in economics earlier. But now we incorporate this as well.
    On the other hand, we also have jealousy. Experiments in Game theory where they might even harm themselves (monetarily) to not face something else psychologically.

To look at an effective solution, we must look at all aspects.

  • We have presidents and prime ministers even claim that there’s no climate change.

This disparity happens because of difference in discount-rates: People have different opinions of future needs. They don’t care about 2070. People not willing to look that far ahead. They just care about maximising current input.
Prof’s personal opinion: this is the biggest hurdle.

Contours

Suppose you want to convince an agriculturalist to take something organically better → even though the new technology is costlier and yield is not as much. (Micro issue)
Macro: How do you design trade pacts? Suppose there’s a country which only wants clean tech but some other one does not care at all. How do you maintain that your agents continue using clean tech. The problem is that often these clean techs are costlier and less efficient. You have to incentivise people somehow to continue using clean.

Issues

Clean techs costlier but long term benefits. Dirty techs will lead to future depletion of nutrients. Question of cost benefit analysis.

Need a concept of environmental audit → to make good policies.

Some countries: Give a deadline that we’ll cut down to 30%-40% by some deadline. There’s a tussle. You have to keep your growth levels but also protecc environment.

Mechanism design, correlation matrices. → game theory concepts.

Prof explains the prisoner’s dilemma. Due to mis-coordination, we reach an equilibrium which isn’t actually the best.
Same in the case as fishermen. Maybe if they all underfished, they could actually gain. (Since supply is low.) But this requires all of them to trust and sacrifice. If there’s an incentive to cheat → they will :(
Monitoring is very costly or just not possible. Thus, everyone goes for their own best.
Thus, even talking it out can’t help.

Next class: A bit of game theory.

Lecture 2 (3rd March 2019)

  • World Trade Centers → countries come together and decide on usage of clean tech. But it doesn’t go through. Why? Lack of coordination.
  • Let’s look at some Game Theory to model this coordination.
    • Monopoly → not game theory. Only one person.
    • Perfect competition → not game theory either. No one is affected by the others.
    • Game theory when fewer players.
      • Example: telecom operators in India. Only 3-4 main, one affects the others.
  • Nash equilibrium: A Nash equilibrium is a situation in which economic actors interacting with one another each choose their best strategy given the strategies that the others have chosen.
  • Prisoners’ Dilemma: provides insight into the difficulty of cooperation. Firms don’t cooperate even though both would be better off with cooperation.
  • Example given: Exxon vs Chevron in slides
    • Game theoretic situation since the acts of the other guy affects my payoff.
    • Optimal is clearly if Exxon and Chevron both drill one well each. Maximises total profit.
    • However, that won’t happen. You have to find out the firm’s best response. That is, given the other person’s decision, I must find my best strategy.
    • Suppose I’m Chevron’s CEO.
      • Exxon drills two wells: Then, I should drill two wells as that’s the better option
      • Exxon drills one well: My best response is still to drill two wells.
    • Thus, drilling two wells is the best response of Chevron no matter what Exxon does.
    • Conversely, best response for Exxon is always drill two ways.
    • Typical case of prisoners’ dilemma. There’s dominant strategy → best response is the same regardless of opponent’s strategy. However, this lands you in an inferior equilibrium.
  • Dominant strategy: The best strategy got a player to follow regardless of the strategies of chosen by the other players.
  • The above case is a static game → simultaneous game, one-period game. Played just once. Not that I play today, then tomorrow, …
  • Now suppose that I change it from a static game to a repeated game.
    • Suppose the game is repeated twice.
    • \(\Pi^C = \Pi^C_1 + \beta\Pi^C_2\). \(\Pi_C^i\) → payoff that Chevron gets on day \(i\). \(\beta \in [0, 1]\)
    • Recall discount rate: People value current profits more.
      • Extreme case of \(\beta = 0\): only care about today’s profit. Extreme patience.
      • Extreme case of \(\beta = 1\): very patient. Giving him hundred rupees tomorrow is as good as him being paid today. In theory, such a person would be fine with being given 0 interest from a bank.
      • Theoretically: \(\beta > 1\) is also possible. Extremely calculative. You worry more about what’s going to happen in future.
    • If three days: \(\Pi_C = \Pi_C^1 + \beta\Pi_C^2 + \beta^2\Pi_C^3\).
    • Firm will try to maximise \(\Pi_C\).
    • Even in the case of two days: Nothing will change :(
      • Backward induction: Start at the last day. Consider what will be played on Day - 2. Given you know what is happening on Day - 2, you decide what to do on Monday.
      • Question: How do we account for \(\beta\)?
      • For the last day, it’s a static game. On Day-2, if you do anything “bad”, then you don’t have any consequences to face. No fear of “punishments” or hope of future “reward”.
      • Thus, on Day-2, do 2well-2well-4-4.
      • But now since they know that Day-2 will have that outcome, there’s no point in doing anything good on Day-1.
      • As there was no “punishment”, the equilibrium will be to do the thing that you did in the static game everyday.
      • Even if played 9000 times, the same will happen.
      • Side note: this was very nice and easy because there was a dominant strategy. Trivial. However, in 99 percent of the games, you don’t have a dominant best response. Then, you might get different results.
    • Dynamic games:
      • Finite type: Can use backward induction to solve the game
      • Infinite type: No last round, can’t use backward induction.
    • Question: Is there no hope? Can we never have the optimal case? (1 well-1 well-5-5)
      • Answer: Fret not! There is. Only if \(\beta\) is sufficiently high and the game is played infinitely long. (Assumption: \(\beta\) is same for both. But there is a cutoff that both have to exceed.)
      • But this is highly dependent on both parties seeing future payoffs in high regards.
      • Result:
  • Externality: Affecting others who aren’t buyers/sellers. The effects aren’t limited to buyers and sellers. They are spilled over to third parties. However, economic discussions don’t take this into account.
    • Smoking: passive smoking is the externality.
      • Supply for cigarettes: By company
      • Demand for cigarettes: By buyer
      • The person sad: Third guy >:O
      • This guy had no say in the economics of supply-demand in the market.
    • AC: environment degradation is the externality
    • Furniture making company: rapidly cut forests because they see that the demand is high
      • Air quality bad because of cutting
      • Neither the store nor the consumers take care of that

Lecture 3 (5th March 2020)

  • Recap: Countries don’t continue their promises. Coordination is tough. Static (one-time game) or finite game → prisoner dilemma type scenario, impossible to maintain cooperation. (Even though cooperation would’ve been beneficial for everyone.)
    • Only possible if you keep \(\beta\) high enough. Care highly enough about future. Recall the overlapping generation model. “How much you consume in your lifetime and how much you leave for your children.”
      • Again depends on discount rate. How much do you care for your children/grandchildren?
      • How much they care is a big factor.
  • “migation”, “correlated equilibrium”, “sunspot equilibrium” → technical terms, is there a role of a third party? In the previous case, we didn’t take it into account.
  • “strategic delegation” → choose not to act yourself but delegate the power of acting to a third party. Can show that in certain cases, delegation actually improves the outcome (with different amount of skills, information), that is, a better outcome for everybody.
    • In infinite case, and \(\beta\) is sufficiently high, we don’t need a third party to get a good equilibrium.
  • Recall: Adam Smith’s “invisible hand”. Just by the forces of supply and demand, we get equilibrium. No third party.
    • However, not always true. Market failures can still happen and the invisible hand alone can’t do it.
  • Externality: An uncompensated impact of one person’s actions on the well-being of a bystander.
    • invisible hand never talk about this.
    • recall the examples of earlier (smoking, buying AC, et cetera)
    • (negative) externalities cause markets to be inefficient and thus fail to maximise total surplus
      • positive externalities could also exist (vaccination, buying a plant, medical research)
    • When the impact on the bystander is adverse (beneficial), the externality is called a negative (positive) externality.
    • Negative externality: leads to markets producing larger quantity than is socially desirable.
      • More things lead to more dissatisfaction of the third parties but the market forces don’t take this into account.
    • Example: The market for aluminum
      • Quantity produced and consumed is efficient in the sense that it maximises surplus of producer and consumer.
      • However, if it emits pollution, that is not taken into account and thus, society as a whole has a problem.
    • Another example: Upstream/downstream firm
      • A firm (called upstream) is having an impact on another (downstream) which is not taken into account.
  • Internalising an externality: incorporate the externalities
    • Internalising an externality involved altering incentives so that people take account of the external effects of their actions.
    • Government can really do two things:
      • tax
      • subsidise
    • Government can tax companies to recover the social costs. This shifts the supply curve upwards. → gives social optimum
  • Positive externality: analogous to the earlier case
    • If there is a positive externality, you should be willing to pay more as it has more benefit. That is, the social demand curve should be higher than the true demand curve.
      • (depending on the story, it could be that the supply goes lower)
    • here, the government will encourage this by subsidising (internalising)
  • Positive externality from RnD → however, people can later steal my ideas :(
    • Government encourages RnD by enforcing strong patent laws. Companies sufficiently assured.

Lecture 4 (12th March 2020)

  • Recalling externalities: AC, smoking, et cetera
  • Public goods: apply free of charge. No supply-demand interaction.
    • analysis of supply and demand won’t work
    • private enterprises can’t ensure the production and consumption of goods in proper amount
      • they don’t care since no profit for them. Won’t enter market.
    • If you’re willing to pay money for product (like clean air, air purifier), then private enterprises will be interested.
    • But stuff like clean air is important. Thus, we need a non-profit-caring party like a government or NGO.
  • Excludability: property of a good whereby a person can be prevented from using it.
    • example: private land, can prosecute someone for trespassing
  • Rivalry: property of a good whereby one person’s use diminishes other people’s use
    • example: cake. If I eat cake, you can’t (lol sad)
  • Four types of goods:
    • Private goods: excludable and rival
      • oil
      • ice-cream cones
      • clothing
    • Public goods: neither excludable nor rival
      • [fairly large] public parks (assuming not very congested)
      • national defense
    • Common resources: rival but not excludable
      • tree with fruits
      • fish in ocean
    • Natural monopolies: excludable but not rival
      • private parks
      • telecom operators
  • Free-rider: person who receives the benefits of a public good but does not pay for it
    • since people can’t be excluded from enjoying the benefits of a public good, individuals may withhold paying for it hoping someone else will pay for it
      • tax evasion. Why should I pay taxes if I know that government will get money for national defense, etc. anyway. Not like they can stop me from using it.
    • the free-rider problems prevents private markets from supplying market goods.
      • people don’t pay. Everyone wants to be a free rider. Since it’s a non-excludable and non-profit product, no one wants to pay. Coordination issue again.
        Could’ve been possible that even after paying, they would have net benefit. But they still won’t pay.
        Somewhat similar to prisoner’s dilemma. Not exactly because no (strictly) dominant strategy.
  • free-rider problem: who will free ride? Sequence of playing is important.
    • first mover’s advantage in some cases and second mover’s advantage in some others.
      • first mover’s: Tic-Tac-Toe
      • last mover’s: two people open a restaurant. First guy makes his menu. The other makes the same menu but one rupee lesser.
        • In this setup, everyone will wait for others to play first.
        • the discount rate has to be kept in mind. Waiting for others to play stalls the project into the future. Cannot wait forever. I’ll play anyway even if I have to forgo the last mover’s advantage.
        • Three people: L, M, N. They want a park but only two are required to pay. A person goes door to door asking people to contribute.
          L approached first. Then M, then N.
          Everyone has two choices: contribute (C) or not-contribute (NC). Two outcomes: park made (P) or not made (NP)
          • Suppose here are the values: → NC, P: 4
            → C, P: 3 → NC, NP: 2 → C, NP: 1
          • Is there a first mover’s advantage or last? Draw a game tree!