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Economics 309 – The Economics of a
Sustainable Society (Special thanks to Deborah Keeth for sharing her excellent answers, which serve as the key for this exam. –SH) This is a take-home examination, and in turning in this exam with your name on it you are pledging that ALL of the answers you have provided represent your own work, and thus you have not collaborated with any other students. Violating this pledge constitutes academic dishonesty. According to the HSU Catalog 1998-99, pp. 348-49: "Academic dishonesty is willful and intentional fraud and deception to improve a grade or obtain course credit. It includes all student behavior intended to gain academic advantage by fraudulent and/or deceptive means. Examples include … working together on a take-home test or homework when not specifically permitted by the instructor." … If the faculty member believes that academic dishonesty has occurred, "the instructor may assign an "F" or "0" on the exam or project or for the course." NAME: __________________________________________
Please provide the very best answer you can to each question below. Word-process your answers and attach them to this question sheet with your name written clearly above. Part I: Computational Analysis (25 points) Problem A: $ Cost Savings from Purchasing a More Fuel-Efficient Natural Gas Furnace:
Note: In year 0 you can purchase an 80% efficient furnace for $1500, or a 90% efficient furnace for $2100. Thus the 90% efficient furnace costs $600 more than the 80% efficient furnace, but generates energy cost savings over the five year period as shown above. Consequently without discounting the more efficient furnace pays for itself over the five year period.
Problem B: Consider two possible ways that a renewable but exhaustible natural resource owned by a profit-maximizing firm can be harvested ($ figures are in millions): --Method 1: Yields an annual dollar-equivalent net benefit of $10,000 forever. --Method 2: Yields an annual dollar-equivalent net benefit of $50,000 in years 0, 1, 2, and 3; thereafter the resource is exhausted.
a. r = 2 percent b. r = 5 percent c. r = 10 percent d. r = 15 percent
Problem A Answer: PDV = -$600/(1+0.1)o + $120/(1+0.1)1 + $120/(1+0.1)2 + $130/(1+0.1)3 + $130/(1+0.1)4 + $140/(1+0.1)5 = -$118.35 When discounted at 10%, the cost savings from a 90% efficient furnace over a 5 year time period does not pay for the additional $600 in up-front cost. Discount rate of 5% PDV = -$600/(1+0.05)0 + $120/(1+0.05)1 + $120/(1+0.05)2 + $130/(1+0.05)3 + $130/(1+0.05)4 + $140/(1+0.05)5 = -$47.92 When discounted at 5%, the cost savings generated from a 90% efficient furnace still does not pay for the additional investment. At both a 10% discount rate and a 5% discount rate, the opportunity cost of investing in the capital of a 90% efficient furnace over a 80% efficient furnace is too high. While the 5% discount rate comes closer to the more efficient furnace paying for itself, the expenditure, at either rate, would be a loss over a five year time period. Problem B Answer: (All $ figures are in millions) Method 1: PDV = $10,000/r r = discount rate Method 2: PDV = $ / (1 + r)n r = discount rate n = year a. Discount rate 2% Method 1: $10,000/0.02 = $500,000 Method 2: $50,000/(1+0.02)0 + $50,000/(1+0.02)1 + $50,000/(1+0.02)2 + $50,000/(1+0.02)3 = $194,194.17 Method 1 maximizes the present discounted value of the resource to the firm. b. Discount rate 5% Method 1: $10,000/0.05 = $200,000 Method 2: $50,000/(1+0.05)0 + $50,000/(1+0.05)1 + $50,000/(1+0.05)2 + $50,000/(1+0.05)3 = $186,162.40 Method 1 maximizes the present discounted value of the resource to the firm. c. Discount rate 10% Method 1: $10,000/0.10 = $100,000 Method 2: $50,000/(1+0.10)0 + $50,000/(1+0.10)1 + $50,000/(1+0.10)2 + $50,000/(1+0.10)3 = $174,342.60 Method 2 maximizes the present discounted value of the resource to the firm. d. Discount rate 15% Method 1: $10,000/0.15 = $66,666.67 Method 2: $50,000/(1+0.15)0 + $50,000/(1+0.15)1 + $50,000/(1+0.15)2 + $50,000/(1+0.15)3 = $164,161.25 Method 2 maximizes the present discounted value of the resource to the firm. Discussion Answer: Economics recognizes the need to discount expenditures because $1 worth of benefits in the future are worth less than $1 worth of benefits today. The higher the risk or opportunity cost associated with the expenditure or method, the higher the discount rate used. This is clearly illustrated in many capitalist financial markets, where a high opportunity cost of capital generates high discount rates. In order to achieve dynamic efficiency, a profit-maximizing firm must compare which project or investment achieves the highest PDV of profits, and generally speaking, the higher the discount rate the shorter the time horizon over which those profits must be generated. Discounting and dynamic efficiency may be inconsistent with sustainability. Problem A illustrates that over a short time period, investment in a more efficient technology appears to lead to a loss. This is because application of a short time horizon conflicts with the long-term time horizon implicit in the idea of sustainability. Problem B illustrates that as discount rates increase, the alternative that yields the greatest PDV of net value switches from sustainable to non-sustainable methods. Yet even relatively low discount rates may be inconsistent with sustainability when there is little or no substitutability is allowed between human-made and natural capital. Thus society may have to consciously decide to make policy choices that are not dynamically efficient from a discounting point of view, but which are held to be necessary socially from a sustainability point of view.
Part II. (75 Points): Your grade on these questions will reflect the quality and completeness of your analysis, research, arguments, and writing style. Read the question carefully, and be sure to respond to each part of a given question. Strive to be objective. Answer each of the questions below (each is worth 15 points; clearly indicate which question you are answering): 1. Do some research and summarize one or more published papers or books (not including your textbook) that describe sustainability as an ethic. Briefly but succinctly describe the key elements of sustainability as an ethic. Question 1 Answer: According to the World Commission on Environment and Development, sustainable development is "development that meets the needs of the present without compromising the ability of future generations to meet their own needs."1 While scientists, politicians, and environmentalists all must be included in the continually evolving process of determining the best course of action for meeting that criteria, many propose it is equally important to include the "poets, priests, philosophers, and artists. For the conservation of nature is above all an ethical matter."2 Traditional African societies have been forwarded as one model that espouses sustainability as an ethic. Dr. Jimoh Omo-Fadaka, former Regents Professor of Environmental Studies at UC Santa Cruz, in his article "Communalism: The Moral Factor in African Development", observes that most "non-industrial countries possess a conservation ethic within their own cultural setting." Two cultural factors compatible with sustainability that he and author C. K. Omari, in his article "Traditional African Land Ethics"3, identify as common to most traditional African societies are religion and communalism. It is important to explore each of these factors in order to understand some of the strengths of the traditional African ethical system as a system of sustainability. Most traditional societies have a strong religious belief rooted in the fact that God is all- powerful and God has given people everything that is on earth. This religious attitude has lead to a reverence for natural resources that serves many community’s spiritual and physical needs. Dr. Omari, an associate professor of sociology at the University of Dar es Salaam, believes that "out of their religious beliefs and values and their reverence for sacred places, an ecological and environmental concern was developed." In fact, according to Omari, it is nearly impossible to separate religious and social actions because they are so woven into the fabric of the community through ceremony, myth, story, and song. One important ethical belief common to most traditional societies is that natural resources must be preserved for present and future generations because God has entrusted these resources to the care of the people. Specifically, taboos and restrictions exist on cutting trees and shrubs in sacred areas, and killing rare and endangered animals because these actions may displease God. Omari points out that "to dismiss these religious attitudes and values because they were suited to an underdeveloped, pre-modern world is not to appreciate the community function they served with respect to ecology and conservation." The second important cultural factor common to most traditional African societies is communalism. Communalism, according to Omari, recognizes that there is a difference between ownership rights and possession rights. Many traditional societies believe that a social group, made up of the living and the dead, own the land and the natural resources. This ethical system of communal ownership is consistent with sustainability because "each individual who used the land felt a communal obligation for its care and administration before passing it to the next generation." While ownership rested with the group, it was obligatory that "ethical considerations in land distribution" assured that every member of the group had enough land to cultivate. This division of resources based on need and group consensus applies to other natural resources as well, including water and firewood, and assures a more equal and just society. Religion and communalism are the basis for a system of ethics in traditional African societies that inherently promotes sustainability. While some of the specific taboos and restrictions may be better-suited to traditional Africa than a modern industrialized nation, there are core concepts shared by all models of sustainability as an ethic. One key element is to regard future people as we regard ourselves. There must be a consideration for what has been popularly coined the "seventh generation." A second element is that there must be some concept of communal stewardship of natural resources. This allows for a system of checks and balances in the use and misuse of common property. A third element of sustainability as an ethic is that moral consideration must be given to non-human animals and non-sentient nature. Finally, the decision-making process must include input from a broad spectrum of society and include indigenous people and traditional practices.
2. I argue that a sustainable society rests upon the three pillars of economy, community, and environment, and that their productive capacity and functional integrity in turn depends on the five capitals – human, constructed, natural, social, and cultural. Briefly but succinctly explain why economy is included in the three pillars. What would happen if we left economics out? Question 2 Answer: While there is no general formula that can be developed and then applied to all communities seeking sustainable development, there are certain building blocks that must occur in each. Stephen Viederman, in his article in "Building Sustainable Societies"4, argues that all sustainable societies must rest on three pillars: economy, community, and environment. Each of these pillars is equally important, and with the loss or breakdown of one foundation, like a building made of wood and stone, the entire structure will crumble. In order to see the importance of the economic pillar in achieving sustainable societies, it is necessary to briefly review the history of environmental economics and then consider two questions each society must address regarding throughput. Finally, one must consider what would happen if economics was not included as one of the pillars. A historical perspective of environmental economics must begin, according to Dr. Brian Hill in his Summer 1991 Economics article5 , with Thomas Malthus. He surmised that with a fixed land area (or natural resource amount) and steady population growth, economic growth would proceed until it reached a plateau and plummeted. John Stuart Mill argued that technology could raise the plateau, but that ultimately scarce resources would constrain economic growth. With the opening of the North American frontier, the land constraint issue was essentially forgotten until the 1960s. Around that time, the model of "green" economics emerged and proposed to study the "maximization of welfare subject to all current constraints and future sustainability." The terms "economics" and "ecology" come from the same Greek word, "oikos", meaning "management of household." Sustainable development, and the pillars it rests on, propose to address our earth’s household management. In managing a societies household, two essential questions regarding resources, or throughput, must be addressed, according to Herman E. Daly in his book Steady State Economics.6 The first question, referred to as the scale question, is "what should determine throughput’s total volume?" The second question, referred to as allocation, is "what should determine allocation among various uses?" Daly argues that the answer to the allocation question should be decentralized and decided by a price system or free market. The answer to the question of scale, however, should be a collective social (community) decision. The reasoning is that two value judgments must be made in determining scale: how far to base the economic system on "takeover" of habitats of other species; and how far to base the economic system on the "draw down" of capital. It is because of the finite nature of our natural resources that in answering each of these, the ethics of justice and sustainability must be considered. Daly concludes that managing our household must include an "integration of economics and ecology and an explicit consideration of ethical values collectively" — economy, environment, and community. It is not really possible to separate or remove economics from the pillars of community and ecology. Scarcity is a universal aspect of human life and our interactions with each other and the environment. We may live our lives in ways that reduce contrived sources of scarcity, but aspects such as our time and energy are and always will be scarce, and thus economics is involved. All societies must made economic choices regarding what, how, and for whom to produce, including sustainable societies. One example would be finding ways to meet basic human needs and providing stable and satisfactory work for people while working within the integrity of community and environment. The relationship between economy, community, and environment has been eloquently stated by farmer and author Wendell Berry who believes "the answers to humans problems of ecology are to be found in the economy. And the answers to the problems of the economy are to be found in human culture and character."7
3. Why is it that education, empowerment, and justice are both directly and indirectly related to the three pillars and five capitals of sustainability? Summarize and fully cite one or more published papers, reports, or books (not including your textbook) that describe the validity and importance of these relationships. Question 3 Answer: Throughout the literature on sustainable development, three themes that make up the foundation of the movement appear: environment, economy, and community. And while the verbiage is not always the same, it is commonly agreed that there are five capitals — human, constructed, natural, social, and cultural —that make up the productive capacity and functional integrity of the pillars. While there is great strength in this construction, many would argue that the "wheels" on the continual process of sustainable development will not begin to turn without a society-wide dedication to improving education, empowerment, and justice for all people in each community. Stephen Viederman is the founder of the theory of the three pillars and the five capitals and their relationship to one another, and there is no need to evaluate that relationship here. What is necessary is to consider Viederman’s thoughts on the validity and importance of education, empowerment, and justice to sustainability. It is then informative to consider the state of Kerala in India as a valid example of these relationships and their importance. Viederman introduced the three pillars and five capitals in his article in the book Building Sustainable Societies: A Blueprint for Post-Industrial World.8 In another article, titled "Sustainable Development: What is it and how do we get there?"9 , Viederman discusses education, empowerment, and justice as they relate to the pillars and capitals. If Viederman’s model can be accepted as a method for approaching sustainability, then he argues that it must be so that "social justice and equity are central to the world view of sustainable development." Speaking specifically to empowerment, Viederman believes that "if sustainability is to be achieved it requires the direct attention of the sustainability movement that is truly inclusive in its membership and outreach." All member of a society must be given the voice to help make the ethical and practical decisions necessary. A method for empowering people is to educate them, and Viederman acknowledges that "a new sustainable movement will have to help people make the move to more sustainable livelihoods by providing its support and understanding." Education cannot always come from the top down, and "’trickle up’ must become the model as grassroots activists network among themselves... what is needed now is dialogue and learning." Many studies have shown that the education and empowerment of women leads to great gains in the social welfare of a community. This type of social justice is where the "greatest energy must be directed at broadening the roles and improving the status of women." Obviously Viederman understands the important relationship between education, empowerment, and justice that as one is improved on, so are the others, and that only through improving these important areas can sustainability be achieved. Govindan Parayil, author of the article "The ‘Kerala Model’ of development: development and sustainability in the Third World"10 , agrees with Viederman that the "criteria for sustainability should include not only environmental stability and improvement, but social, political, and economic justice." Parayil’s work centers on the state of Kerala in India which has achieved great gains in the three pillars of sustainability over the last few years. For example, in 1991 Kerala was able to achieve: • improved heath through low infant mortality rate of 16.5/1000 births compared to the Indian average of 91/1000 • slowed growth through a low birth rate of 18/1000 women compared to the Indian average of 30/1000 • increased education through high literacy rates of 87% for females and 95% for males compared to the Indian average of 39% for females and 64% for males. Overall, Kerala has achieved: improvements in quality of life, improvements in environmental stability, improvements in social and economic inequality, and a decline in political strife. Parayil believes that Kerala was able to make these gains in the three pillars through education, empowerment, and building of social justice in their communities. The statistics on literacy rates are one example of how Kerala improved the education of its people. From this education, the people were empowered and the "success in improving indicators of progressive social change occurred because the policies that brought about these changes were implemented without coercion." The people were educated and empowered enough to make their own decisions about how to improve their lives and social justice was achieved. Education, empowerment, and justice led to increases in social capital as large numbers of Keralans began taking part in politics, social movements and NGOs working in environmental protection, culture, and education. Parayil summarizes that "Kerala has stood out in demonstrating through democratic means that radical improvements in the quality of life of ordinary citizens are possible." Education, empowerment, and justice are necessary areas that must be considered and improved in order for the three pillars and five capitals of sustainability to manifest. The importance of this position has been argued by the founder of the pillar and capital model, Stephen Viederman. It has also been validated by working examples such as the Kerala state in India.
4. Why is it that many of the traditional forms of international development assistance through the World Bank and the IMF led to rising indebtedness, declines in world commodity prices, and unsustainable depletion of natural resources in lower-income countries? Explain how this relates to the findings of the Brundtland Commission Report. Summarize the key elements of the Brundtland Commission Report. Question 4 Answer: Conventional economic development programs have largely been a failure to the developing countries they were supposed to have serviced, according to the Brundtland Commission report. Inherent problems in the structure of the programs has led to rising indebtedness of the borrowing country, declines in the world commodity prices, and unsustainable depletion of natural resources in lower-income countries. These findings were identified in the report and two key concepts regarding needs and limitations were outlined. To understand the problems with conventional economic programs that have led to the a call for alternative models, it is necessary to examine the cyclic nature of the problems. The rising indebtedness of borrowing countries began with traditional economic assistance programs that focused on the promotion of economic growth through high dollar investment in large infrastructure projects. This type of program, featured by organizations such as the World Bank and the IMF, has been based on economic development programs used for reconstructing industrialized countries after World War II. It is inappropriate to assume that a system designed for countries that already had infrastructure patterns in place and large urban centers of population would work for countries with little to no infrastructure and a mostly rural population. Many of the projects are financially unsound because of a failure of democratic process and enormous debt repayment. Corrupt government officials and military dictators often borrow enormous sums of money for large projects and then appropriate the money, leaving the people with the debt. Family monopolies of construction and engineering firms are often awarded the large contracts and reap huge benefits. If and when the project comes to completion, a low revenue stream makes it impossible for the borrowing countries to repay the loans. In severely indebted countries (SILICS) loan repayment exceeds 80 % of the overall economy and leads to spiraling indebtedness. A financial crisis in the 1980’s caused by the large default rate of indebted countries led to Structural Adjustment Programs (SAP) and Structural Adjustment Loans. These programs were designed to repay the loans and bail out the private banks, not help the indebted countries. One of the major reforms of the SAPs was a strong focus on production of natural resources for export. Natural resources make up over 60% of the overall economy for low-income countries. The focus by SAPs on export production flooded the market with natural resources and led to a 20% drop in the commodities prices in 1998. This drop in price for items such as wood, oil, and minerals is a boon for the developed world, but an increasing problem for the countries struggling to repay debt. In order to continue repaying loans, indebted countries are forced to harvest natural resources at an unsustainable level for a continually decreasing price. In 1987 the Brundtland Commission of the World Commission on Environment and Development identified the problems associated with traditional economic programs and devised a definition of sustainable development. Perhaps the most important results of the report are two key concepts dealing with needs and limitations. Identification that the concept of needs, in particular the essential needs of the worlds poor, should be given overriding priority arose out of a review of the reforms demanded by the SAP. As social and domestic spending were reduced, the people suffered from reduced education, health care, and infrastructure. Staggering unsustainable harvests of natural resources in an effort to repay loans prompted the idea of limitations imposed by the state of technology and social organization on the environment’s ability to meet present and future needs. It is reports from groups such as the Brundtland Commission that lead to calls for reassessment of the way we try to solve problems. Note: all statistics taken from Economics 309 class notes
5. Pick one of the measures of sustainable development that adjusts GDP based on a variety of social, economic, and environmental factors. Describe how this measure is computed in detail. Critically evaluate this measure. To what extent does it help us better gauge progress toward a more sustainable macroeconomy? What are the practical and theoretical/conceptual shortcomings of this measurement, including the strong-form sustainability arguments? Question 5 Answer: It has been argued in many forums that Gross Domestic Product (GDP) is a incomplete indicator of both the financial well-being of a nation and the welfare of its people. Because we need accurate measurements in order to assess performance in all arenas, but specifically in sustainable development, it has been proposed numerous times that GDP be modified to present a more complete picture. One of these proposed modifications is Ophelia Yeung and John Mathieson’s "development web" model.11 In order to gain a complete picture of this model, it is important to look at the details of how the measurement device works, compare the new model to the old method of gauging sustainable progress, and evaluate the outcome. In order to achieve a more "comprehensive and balanced development measurement," the authors devised a six vector model that allows for the evaluation of magnitude in six categories of indicators of development on a hexagonal web. The categories include: economic performance, competitiveness foundations, health, education, environment, and democracy and freedom. Within each vector, quantitative and objectively measurable indicators were chosen through a three step process. First, "a wish list of optimal variables, assuming a world of perfect data availability," and all reputable sources of data were identified. Then, a working list was developed that examined data using such criteria as reliability, neutrality, and comparability. Finally, interviews were conducted with specialists in each field to review the working list. Examples of what types of indicators were chosen in each category include: • Economic Performance: average GDP growth • Competitiveness Foundations: openess of economy • Health: life expectancy at birth, maternal mortality rate, and HIV prevalence among adults • Education: Adult illiteracy rate and enrollment indicators • Environment: access to safe water, per capita carbon dioxide emissions, and number of registered NGOs • Democracy and Freedom: civil liberties and political rights A scoring system was designed for each of the indicators within the vectors which assigns to them numerical value between 0 and 4. Each indicator was then weighted according to relative importance, quality of data, and available country coverage for a total of 100 points per vector. The development web illustrates the maximum achievable score, "benchmark standards", and the actual status of each of the 108 countries reviewed. The "development web" model is a step in the right direction toward a better measurement of sustainable development because it addresses the complex nature such a measure involves. It acknowledges and begins to evaluate categories of progress within the three pillars of sustainable development : economic vitality, ecological integrity, and democratic process. The web model of development, while more comprehensive than GDP, contains some problems inherent in the development of a new method in a new field of study. The biggest issue is objectivity. Objectivity must be questioned in the process of weighting indicators. It is difficult to determine which indicators are "more important" and should therefore be weighted more heavily when importance may vary from country to country. There is also concern regarding objectiveness of sources. While the authors tried to carefully screen indicators and their sources, much of the data was supplied by the World Bank in their World Development Report 1996. This indicates that only traditional data available from traditional sources was computed. This reliance on traditional methods completely ignores the arguments of strong form sustainability because its core concepts of uncertainty, irreversibility, and scale effects have not been, and may not ever be, measured by a traditional source. Human, cultural, and social capital also have not yet been measured by a traditional method. All of these, therefore, could not be included in the "development web" model.
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