WT 2022/23

ENVIRONMENTAL AND RESOURCE ECONOMICS

Chapter 2
Externalities, Public Goods and Sustainability

Prof. Dr. Karen Pittel

Agenda

2.1 Externalities

2.2 Public Goods and Common Pool Resources

2.3 Sustainability and Sustainable Development

2.3.1 Sustainability in Economics

2.3.2 Sustainability Concepts
2.3.3 Examples of Sustainable Development Indicators

References:
Neumayer, E. (2003), Weak and Strong Sustainability, Cheltenham: Edward Elgar.

2
This Chapter’s Questions

What are (reciprocal) externalities and how do they affect the market equilibrium and the
welfare optimum?

Can bargaining contribute to solving environmental problems under incomplete information?

What is sustainability and/or sustainable development? Under which conditions is

development sustainable?

(How) can sustainable development be measured?

3
2.1 Externalities

Externalities

... arise if the production/consumption of an agent impairs the production/consumption of other

agents and no compensation takes place via markets.

Pollution most prominent example for negative externalities.

Positive externalities in the context of the environment: e.g. afforestation

→ beautification of landscapes, prevention of erosion, improvement of air quality, CO2 sinks.

Externalities caused by missing (or unenforceable) property rights.

Market equilibrium not socially optimal without internalization of property rights.

4
Property rights in the case of environment and
resources

− Non-renewable resources

 Property rights usually defined (e.g. oil, coal, minerals)

− Renewable resources

 Property rights partially defined (e.g. forests) and partially not (e.g. fish stocks in
international waters)

− Environmental (as sink for pollution)

 Property rights usually not defined (e.g. air, climate)

5
Externalities, market equilibrium and welfare optimum
Example 1: Simple negative environmental externality
− Production of good 𝑥𝑥 results in damages (external costs) to households
− Demand for 𝑥𝑥: 𝑝𝑝(𝑥𝑥)
𝑝𝑝
− Private marginal cost of production: 𝐶𝐶𝑥𝑥 (𝑥𝑥)
− External marginal cost of production: 𝐶𝐶𝑥𝑥𝑒𝑒 (𝑥𝑥)
𝑝𝑝
− Social marginal cost of production: 𝐶𝐶𝑥𝑥𝑠𝑠 (𝑥𝑥) = 𝐶𝐶𝑥𝑥𝑒𝑒 (𝑥𝑥) + 𝐶𝐶𝑥𝑥 (𝑥𝑥)

𝑝𝑝, 𝐶𝐶𝑥𝑥𝑠𝑠 , 𝐶𝐶𝑥𝑥𝑝𝑝 , 𝐶𝐶𝑥𝑥𝑒𝑒 𝑪𝑪𝒔𝒔𝒙𝒙

𝒙𝒙∗ = quantity in welfare optimum
𝒑𝒑(𝒙𝒙)
𝐶𝐶𝑥𝑥𝑝𝑝 𝑝𝑝 𝑥𝑥 = 𝐶𝐶𝑥𝑥𝑠𝑠 (𝑥𝑥)
𝒙𝒙𝑴𝑴 = quantity in market equilibrium
𝐶𝐶𝑥𝑥𝑒𝑒
𝑝𝑝 𝑥𝑥 = 𝐶𝐶𝑥𝑥𝑝𝑝 (𝑥𝑥)

𝒙𝒙∗ 𝒙𝒙𝑴𝑴 𝑥𝑥

6
Example 2: Reciprocal environmental externalities

− 𝑛𝑛 households (alternative: firms or nations), 𝑖𝑖 = 1, … , 𝑛𝑛

− Consumption of a good results in emissions that cause damages (costs) to all households
(household knows it causes damage to itself!)
→ Damage to one household depends on aggregate emissions of all households.

− 𝑈𝑈𝑖𝑖 𝐸𝐸𝑖𝑖 = utility of household 𝑖𝑖 from own emissions

𝜕𝜕𝑈𝑈𝑖𝑖 (𝐸𝐸𝑖𝑖 ) 𝜕𝜕 2 𝑈𝑈𝑖𝑖 (𝐸𝐸𝑖𝑖 )
(𝑈𝑈𝑖𝑖 𝐸𝐸 = 𝜕𝜕𝐸𝐸𝑖𝑖
> 0, 𝑈𝑈𝑖𝑖 𝐸𝐸 𝐸𝐸 =
𝜕𝜕𝐸𝐸𝑖𝑖2
< 0)
𝑖𝑖 𝑖𝑖 𝑖𝑖

− 𝐶𝐶𝑖𝑖 (𝐸𝐸) = damages to household 𝑖𝑖 from emissions of all households (including their own) with
𝐸𝐸 = ∑𝑛𝑛𝑗𝑗=1 𝐸𝐸𝑗𝑗

𝜕𝜕𝐶𝐶𝑖𝑖 (𝐸𝐸) 𝜕𝜕𝜕𝜕 𝜕𝜕 2 𝐶𝐶𝑖𝑖 (𝐸𝐸)

(𝐶𝐶𝑖𝑖 𝐸𝐸 = = 𝐶𝐶𝑖𝑖 𝐸𝐸 > 0, 𝐶𝐶𝑖𝑖 𝐸𝐸𝐸𝐸 = > 0)
𝑗𝑗 𝜕𝜕𝜕𝜕 𝜕𝜕𝐸𝐸�𝑗𝑗 𝜕𝜕𝐸𝐸2
=1

7
Welfare optimum

max 𝑊𝑊 = ∑𝑛𝑛𝑖𝑖=1 𝑈𝑈𝑖𝑖 𝐸𝐸𝑖𝑖 − 𝐶𝐶𝑖𝑖 (𝐸𝐸)

𝐸𝐸1 ,…,𝐸𝐸𝑛𝑛

⇒ optimum: 𝑈𝑈1 𝐸𝐸 = ∑𝑛𝑛𝑖𝑖=1 𝐶𝐶𝑖𝑖 𝐸𝐸

1
𝑈𝑈2 𝐸𝐸 = ∑𝑛𝑛𝑖𝑖=1 𝐶𝐶𝑖𝑖 𝐸𝐸
2
⋮
𝑈𝑈𝑛𝑛 𝐸𝐸 = ∑𝑛𝑛𝑖𝑖=1 𝐶𝐶𝑖𝑖 𝐸𝐸
𝑛𝑛

⇒ 𝑼𝑼𝟏𝟏 𝑬𝑬 = 𝑼𝑼𝟐𝟐 𝑬𝑬 = ⋯ = 𝑼𝑼𝒏𝒏 𝑬𝑬 = ∑𝒏𝒏𝒊𝒊=𝟏𝟏 𝑪𝑪𝒊𝒊 𝑬𝑬

𝟏𝟏 𝟐𝟐 𝒏𝒏

In the welfare optimum…

… the marginal utility that a household gets from emitting is equal to the sum of marginal
damages it causes to all households.
… the marginal benefits from emissions are identical across all households.

8
Welfare optimum (2 households)
𝑈𝑈𝑖𝑖 𝐸𝐸 , 𝑈𝑈𝐸𝐸
𝑖𝑖
𝑪𝑪𝑬𝑬 = ∑𝟐𝟐𝒊𝒊=𝟏𝟏 𝑪𝑪𝒊𝒊𝑬𝑬
𝐶𝐶𝐸𝐸 𝑼𝑼𝑬𝑬 = aggregate = aggregate marginal damages
marginal benefits

𝑪𝑪∗𝑬𝑬 𝐶𝐶𝐸𝐸𝑖𝑖 = individual marginal damages

(for simplicity: identical
𝑈𝑈1𝐸𝐸 marginal damage curves)
1

𝑈𝑈2𝐸𝐸
2

𝐸𝐸1∗ 𝐸𝐸2∗ 𝑬𝑬∗ 𝐸𝐸

Welfare maximizing emissions: 𝑬𝑬∗ = 𝑬𝑬∗𝟏𝟏 + 𝑬𝑬∗𝟐𝟐

𝑼𝑼𝟏𝟏 𝑬𝑬 = 𝑼𝑼𝟐𝟐 𝑬𝑬 = 𝑪𝑪𝟏𝟏 𝑬𝑬 𝑬𝑬∗ + 𝑪𝑪𝟐𝟐 𝑬𝑬 𝑬𝑬∗ = 𝑪𝑪∗𝑬𝑬
𝟏𝟏 𝟐𝟐

9
Utility maximization of household 𝒊𝒊

max Π𝑖𝑖 = 𝑈𝑈𝑖𝑖 𝐸𝐸𝑖𝑖 − 𝐶𝐶𝑖𝑖 (𝐸𝐸) = 𝑈𝑈𝑖𝑖 𝐸𝐸𝑖𝑖 − 𝐶𝐶𝑖𝑖 (𝐸𝐸𝑖𝑖 + 𝐸𝐸�𝑖𝑖 ) with 𝐸𝐸�𝑖𝑖 = ∑𝑖𝑖≠𝑗𝑗 𝐸𝐸𝑗𝑗
𝐸𝐸𝑖𝑖

⇒ In the utility maximum: 𝑼𝑼𝒊𝒊 𝑬𝑬 = 𝑪𝑪𝒊𝒊 𝑬𝑬 𝑬𝑬 , ∀𝒊𝒊

𝒊𝒊

⇒ Marginal benefits from emissions of each household are equalized to the marginal damages its
emissions cause to itself.

⇒ As the household only internalizes the damages from its own emissions, equilibrium emissions
in the decentralized equilibrium are too high compared to the welfare optimum:

𝑪𝑪 𝑬𝑬𝑫𝑫 = ∑𝑖𝑖 𝑪𝑪𝒊𝒊 𝑫𝑫

𝑬𝑬
𝑬𝑬𝑫𝑫 > 𝑪𝑪𝑬𝑬 (𝑬𝑬∗ )

10
Utility maximization (household 1)
Graphical representation: ⇒ marginal damage curves depend on emissions of other household.

� 𝒊𝒊 𝑪𝑪 < 𝑬𝑬
𝑬𝑬 � 𝒊𝒊 𝑩𝑩 < 𝑬𝑬
� 𝒊𝒊 𝑨𝑨

𝑈𝑈𝑖𝑖 𝐸𝐸 , 𝐶𝐶𝑖𝑖 𝐸𝐸
𝑖𝑖 𝐶𝐶𝑖𝑖𝐸𝐸 (𝐸𝐸𝑖𝑖 + 𝐸𝐸�𝑖𝑖𝐴𝐴 )
𝑈𝑈𝑖𝑖 𝐸𝐸
𝑖𝑖
𝐶𝐶𝑖𝑖𝐸𝐸 (𝐸𝐸𝑖𝑖 + 𝐸𝐸�𝑖𝑖𝐵𝐵 )
𝐶𝐶𝑖𝑖𝐸𝐸 (𝐸𝐸𝑖𝑖 + 𝐸𝐸�𝑖𝑖𝐶𝐶 )

𝐸𝐸𝑖𝑖𝐴𝐴 𝐸𝐸𝑖𝑖𝐵𝐵 𝐸𝐸𝑖𝑖𝐶𝐶 𝐸𝐸𝑖𝑖

Decentralized equilibrium: Simultaneous utility maximum of all households (given the emissions of all
other households).

11
Decentralized utility maximization (2 households)

𝑈𝑈𝑖𝑖 𝐸𝐸 , 𝑈𝑈𝐸𝐸
𝑖𝑖
𝐶𝐶𝐸𝐸 𝑼𝑼𝑬𝑬 = aggregate 𝑪𝑪𝑬𝑬 = aggregate marginal damages
marginal benefits

𝑪𝑪𝟐𝟐𝑬𝑬 (𝑬𝑬𝟐𝟐,𝑬𝑬𝑫𝑫
𝟏𝟏 )
𝑪𝑪𝟏𝟏𝑬𝑬 (𝑬𝑬𝟏𝟏,𝑬𝑬𝑫𝑫
𝟐𝟐 )

𝑈𝑈1𝐸𝐸1 𝑈𝑈2𝐸𝐸2

𝐸𝐸1𝐷𝐷 𝑬𝑬∗𝐸𝐸2𝐷𝐷 𝐸𝐸 𝐷𝐷
𝐸𝐸

Decentralized equilibrium: 𝐸𝐸 ∗ < 𝐸𝐸 𝐷𝐷 = 𝐸𝐸1𝐷𝐷 + 𝐸𝐸2𝐷𝐷 and 𝐶𝐶𝐸𝐸 𝐸𝐸 𝐷𝐷 > 𝐶𝐶(𝐸𝐸 ∗ )

12
Correction of market failures from externalities

Internalization = Changing incentives of economic agents such that external costs and
benefits of producers and consumers are considered in production and
consumption decisions.

Public solutions
− Provision of information (labels, product specifications)
− Education
− Command and control (statutory orders, bans,...)
− Taxes, subsidies, certificates
→ environmental policy → chapter 3

Private solutions (e.g. households, firms and non-profit organizations)

− Moral conventions and social sanctions
− Information provision
− Bargaining between the concerned parties: Coase-Theorem

13
The Coase-Theorem
Ronald Coase (1960), The Problem of Social Costs

Internalization of externalities without regulatory intervention

Prerequisite: property rights are defined

Coase-Theorem:

The market equilibrium is welfare optimal if the agents that are affected by the externalities...

have perfect information,

can bargain with each other at no costs (no transaction costs),

independent of whom the property rights are assigned to.

14
Example Coase Theorem
A fisher’s utility from fishing is impaired by the waste water a chemical plant releases into the
river.
Benefits to firm: 𝑈𝑈 𝐸𝐸 , 𝑈𝑈𝐸𝐸 > 0, 𝑈𝑈𝐸𝐸𝐸𝐸 < 0
Damages to fisher: 𝐶𝐶 𝐸𝐸 , 𝐶𝐶𝐸𝐸 > 0, 𝐶𝐶𝐸𝐸𝐸𝐸 > 0

Emissions without bargaining: 𝐸𝐸�

�
Damage reduction for fisher if 𝐸𝐸 < 𝐸𝐸: � − 𝐶𝐶(𝐸𝐸)
𝐶𝐶(𝐸𝐸)
�
Benefit reduction for firm if 𝐸𝐸 < 𝐸𝐸: 𝑈𝑈 𝐸𝐸� − 𝑈𝑈(𝐸𝐸)

Bargaining about 𝐸𝐸-reduction:

Compensation payments but not equilibrium emissions are affected by the
distribution of property rights.

15
Equilibria with alternative property rights assignment

𝑈𝑈𝐸𝐸 ,𝐶𝐶𝐸𝐸 𝐾𝐾𝐶𝐶

𝐸𝐸 𝐸𝐸
𝑈𝑈𝐸𝐸

𝐸𝐸 ∗ 𝐸𝐸�

Property rights assigned to fisher: Emissions after bargaining = welfare optimal emissions 𝐸𝐸 ∗
(Firm compensates fisher as long as its marginal benefits are
higher than the marginal damages to the fisher)

Maximal willingness to pay of firm: + (𝑈𝑈 𝐸𝐸 ∗ − 𝑈𝑈 0 )

Minimal compensation claim by fisher: (𝐶𝐶 𝐸𝐸 ∗ − 𝐶𝐶(0))

16
Equilibria with alternative property rights assignment

𝑈𝑈𝐸𝐸 ,𝐶𝐶𝐸𝐸 𝐾𝐾𝐶𝐶

𝐸𝐸 𝐸𝐸
𝑈𝑈𝐸𝐸

𝐸𝐸 ∗ 𝐸𝐸�

Property rights assigned to firm: Emissions after bargaining = welfare optimal emissions 𝐸𝐸 ∗
(Fisher compensates firm as long as his marginal damages are
higher than the marginal benefits of the firm)

Maximal willingness to pay of fisher: + (𝐶𝐶 𝐸𝐸� − 𝐶𝐶(𝐸𝐸 ∗ ))

Minimal compensation claim by firm: (𝑈𝑈 𝐸𝐸� − 𝑈𝑈(𝐸𝐸 ∗ ))

17
Assessment of Coase Theorem

− Restrictive conditions:
No transaction/bargaining costs and perfect information (e.g. about marginal cost and
benefit curves).

− Conditions often not fulfilled in case of environmental externalities:

e.g. large number of agents results in high transaction costs or can induce strategic behavior.

− While the equilibrium allocation is independent of the assignment of property rights, the
distributional impacts can be very different.

18
The Coase-Theorem with incomplete information (An Example)

Chemical plant can have an incentive to down play its benefits from production in order to decrease its
compensation payment.

Assumptions:
− Property rights assigned to fisher.
− Fisher aims to receive highest compensation possible.
− Fisher has incomplete information about marginal benefits of chemical plant:
� i.e. he knows that
Fisher observes that before bargaining, the chemical plant emits 𝐸𝐸,
𝑈𝑈𝐸𝐸 𝐸𝐸� = 0, but does not know the slope of marginal utility.

�𝐸𝐸 ) than it really is (𝑈𝑈𝐸𝐸 ), allows firm to keep part of its

Pretending that marginal utility is lower (𝑈𝑈
benefits.

19
 (Example contd.)
𝑈𝑈𝐸𝐸 ,𝐶𝐶𝐸𝐸
Both figures:
𝑈𝑈𝐸𝐸 Blue area = compensation paid to fisher
𝐾𝐾𝐶𝐶𝐸𝐸𝐸𝐸
Lower figure:
�𝐸𝐸
𝑈𝑈 • Net utility of firm when stating true
utility → 0 after compensation
payment.

𝐸𝐸� 𝐸𝐸 ∗ 𝐸𝐸� Upper figure:

�𝐸𝐸 .
• Equilibrium for stated utility 𝑈𝑈
𝑈𝑈𝐸𝐸 ,𝐶𝐶𝐸𝐸 • Red area = net utility of firm after
�𝐶𝐶̃𝐸𝐸𝐸𝐸
𝐾𝐾
𝑈𝑈𝐸𝐸𝐻𝐻 compensation payment.

𝐾𝐾𝐶𝐶𝐸𝐸𝐸𝐸
Emissions after bargaining are
�𝐸𝐸
𝑈𝑈
lower than in the welfare optimum
(but: loss of welfare: green
triangle).
𝐸𝐸 ∗ 𝐸𝐸�

20
2.2 Public Goods and Common Pool Resources
Classification of goods:

Excludability

yes no
common pool resources
Rivalry yes private goods (open access resources
→ chapter 6)

no club goods public goods

Problem with private provision of public goods → suboptimal supply

Problem with use of common pool resources → excessive use

21
a) Public Goods
Agent 𝑖𝑖’s utility from provision of public good 𝑥𝑥:
𝑈𝑈𝑖𝑖 (𝑋𝑋), 𝑖𝑖 = 1, … , 𝑛𝑛 with 𝑋𝑋 = 𝑥𝑥1 = 𝑥𝑥2 = ⋯ = 𝑥𝑥𝑛𝑛

Costs of providing the public good: 𝐶𝐶(𝑋𝑋)

Welfare optimal provision: ∑𝒊𝒊 𝑼𝑼𝒊𝒊𝑿𝑿 (𝑿𝑿) = 𝑪𝑪𝑿𝑿 (𝑿𝑿) → 𝑿𝑿∗

Example: 2 agents 𝑈𝑈𝑖𝑖𝑋𝑋 , 𝐶𝐶𝑋𝑋

𝑪𝑪𝑿𝑿
𝑼𝑼𝟏𝟏𝑿𝑿 + 𝑼𝑼𝟐𝟐𝑿𝑿

𝑈𝑈2𝑋𝑋

𝑈𝑈1𝑋𝑋

𝑋𝑋
𝑿𝑿∗

22
Free-rider behavior: The prisoner’s dilemma in the
context of environmental goods

Example: establishment and financing of a nature reserve

− 2 cities have to decide whether they contribute to financing a nature reserve.

− Citizens of both cities can visit the reserve independent of the financial contributions of
their respective cities.

− Per city: budget of 1 Mio €; willingness to pay (= utility from the nature reserve): 300000 €.

− Costs of the nature reserve: 400000 €.

− Financing rule: If both cities contribute, the costs are split evenly.

23
Matrix of net benefits of the two cities (depending on
their decision to contribute or not)

City 1
contributes does not contribute

contributes 1.1 Mio € / 1.1 Mio € 0.9 Mio € / 1.3 Mio €

City 2
does not
1.3 Mio € / 0.9 Mio € 1 Mio € / 1 Mio €
contribute

Welfare optimum: 1.1 Mio € / 1.1 Mio €

Nash-equilibrium: 1 Mio € / 1 Mio €

→ suboptimal provision of public good due to free riding.

24
How to reveal the real willingness-to-pay?
Same example:

− Assumption: Financing of the nature reserve by the region in which both cities are located

− Establishment of the reserve as soon as the stated aggregate willingness-to-pay exceeds

costs.

− Assume the cities are asked the following question: „How highly do you value the nature
reserve?“

1. If the cost shares are determined by the reply:

→ Incentive to understate the willingness-to-pay

2. If the costs are split 50/50 (independent of the reply):

→ Incentive to overstate the willingness-to-pay

→ Question how to elicit an honest reply.

25
b) Common pool resources

Accessible to all members of a group at no costs (nobody can be excluded from using this resource)

BUT: rivalry in the use of resource

→ Usage of the resource by one agent leads to costs for other agents which are not
internalized by the individuum

→ Similarity to negative externality

→ Leading often to a suboptimally high use of the common pool resource

26
A simple example: a common pasture
− Once upon a time there was a hamlet with four families and a pasture that all of the
hamlet’s families could use (for free) to graze their goats on.

− Each of the families can either buy a goat for 100€ or invest the 100€ in government bonds
(interest rate: 12% p.a.).

− The goat can be sold after one year for a price that depends on the amount of feed the goat
got on the common pasture (and thus on the number of goats).

− After one year, the situation is as follows, depending on the number of goats on the
pasture:

Number of goats Price for goats on Overall profits Marginal profit

on the pasture the market in € (goats + bonds) in € per goat in €
1 126 1 � 26 + 3 � 12 = 62 14
2 119 62 0
3 116 60 −2
4 113 52 −8

27
Comparison of individual profit maximization and
welfare optimum
Individual profit maximization: 4 goats (Overall profit: 52)
Welfare Optimum: 1 or 2 goats (Overall profit: 62)

External effect of an additional goat:

Purchase of the 2nd goat: Profit of the owner of the first goat is reduced by 7
Additional profit of the second goat owner: 7

Purchase of the 3rd goat: Profits of the owners of the first two goats are reduced by 6
Additional profit of the third goat owner: 4
…

→ Welfare optimal to buy an additional goat as long as the induced external effect is smaller
than the additional profit from the next goat.

28
2.3 Sustainability and sustainable development

Sustainability = sustainable development?

Sustainability:

− Origin of term “sustainability”: Forestry (Johann Carl von Carlowitz, “Sylvicultura oeconomica”
(1713): Rate of deforestation should not exceed the rate of reforestation).

− 18th and 19th century: idea of “sustainable forest management” adopted throughout Germany
but also in many other countries.

− 20th century: principle's application spread beyond the management of single ecosystems to the
analysis of the entire environment-economy complex.

29
Sustainable Development
− Term coined in 'World Conservation Strategy' of the IUCN (International Union for the
Conservation of Nature and Natural Resources) (1980)

− "Brundtland" commission: WCED (World Commission on Environment and Development) 1987

Definition of sustainable development:

“Sustainable development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs."
(WCED 1987)

− Pearce (1993):
While sustainability of the future does not preclude that the future might be perceived by
humans as being awful, sustainable development is especially considered with human well-
being.

In this lecture: “Sustainable development” and “sustainability” will be used interchangeably

30
3 Dimensions (pillars) of sustainable development

− Ecological:
 Sustainable management of resources (→ see also chapter 6)
 Constant level of natural capital
 Preserving the resilience of ecosystems against shocks
 …

− Economic: see sections 2.3.1 – 2.3.2

− Social
 Equality of opportunities
 Development of social resources/capital (societal values, cultural traditions)
 Political and societal participation of all social groups
 ...

31
Sustainable Development Goals of the UN (2016)

169 sub goals but mostly not quantified; time horizon: 2030

32
Sustainable Development Goals of the UN (2016)
SDG‘s Scores (before the pandemic)

Zhao et al. 2022

Sustainable Development Goals of the UN (2016)
SDG‘s Scores (development 2019-2020)

Zhao et al. 2022

2.3.1 Sustainability in Economics

Numerous definitions

Pezzey (1997): „I see little point in expanding the collection of fifty sustainability definitions
which I made in 1989, to the five thousand definitions that one could readily
find today“

Simplest standard definition:

𝑑𝑑𝑈𝑈(𝐶𝐶𝑡𝑡,… )
̇ 𝑡𝑡,.. ) =
𝑈𝑈(𝐶𝐶 ≥0
𝑑𝑑𝑑𝑑

→ A development path is sustainable if the utility of households (per capita) from

consumption 𝐶𝐶 is non-decreasing over time.

Often: Assumption that utility only depends on consumption and thus translates into non-
decreasing consumption.

35
Non-decreasing consumption over time: How to
compare alternative time paths?
𝑈𝑈(4)
𝑈𝑈

𝑈𝑈(3)
𝑈𝑈(2)

𝑈𝑈(1)

generation 1 generation 3 𝑡𝑡
generation 2

Sustainable paths: 𝑈𝑈(1), 𝑈𝑈(3), 𝑈𝑈(4) Which sustainable path should be chosen?

Non-sustainable path: 𝑈𝑈(2) Is 𝑈𝑈(1) really be preferrable over 𝑈𝑈(2)?

36
Efficiency und Sustainability

B C
yes no
no yes

37
2.3.2 Sustainability concepts

Question: How should the management of environment and resources be designed in order to
assure that utility does not decline over time?

→ Central question: is the substitution of natural capital by other types of capital possible?

Why focus on capital? Capital as durable production factor that allows production in the presence
and in the future.

Types of capital: • Physical capital (machines, buildings, infrastructure)

• Human capital (knowledge and education)
• Social capital (judicial system, culture)
• Natural capital (resources, eco systems)

38
Weak Sustainability and Strong Sustainability
Depending on the degree of substitutability between different types of capital, two types of
sustainability are distinguished:

Weak sustainability: Substitution possible

Strong sustainability: Substitution not possible

Weak sustainability

Minimal condition for a constant level of utility per capita over time:
Constant value of the aggregate capital stock

→ Implication: Degeneration of natural capital unproblematic if other types of (reproducible)

capital are accumulated.
(implicit assumption: Substitution of e.g. resources by other types of capital
possible)

39
Weak Sustainability and Strong Sustainability
Why «value» of capital stock?
− value (price) of different types of capital as indicator for their economic scarcity
– monetary valuation allows comparability of different types of capital

Condition as stated only valid under certain assumptions

− no technological progress
− no population growth

If these assumptions are not valid → Modification of condition required

− technological progress: (some) degeneration of capital stock possible due to rising efficiency
− population growth: value of aggregate capital stock has to rise for the per capita capital
stock to remain constant

40
Weak Sustainability and Strong Sustainability

Strong sustainability

Minimal condition for a constant level of utility per capita over time:

Constant value of natural capital stock

→ no substitution of natural capital by other types of capital possible

→ BUT: Individual types of natural capital might be (completely) substitutable by others as long as
the overall value remains at least constant.

Common element of both sustainability concepts:

− Anthropocentric perspective
− No intrinsic value of nature

41
Critical evaluation of the two concepts
Valuation of the capital stock
For some types of capital, no market valuation through prices exists (especially for natural
capital)
Even if there is a market price, does it really reflect actual economic scarcity?

Limits to substitutability?
Weak sustainability: between natural and others types of capital
Strong sustainability: between different types of natural capital

(Global) life sustaining function of some resources

Irreversibility of the depletion of certain resources (extinction of species)

42
2.3.3 Examples of Sustainable Development Indicators
„Measurement“ of sustainable development by...

− Individual ecological, economic or social indicators

− Multi-dimensional indicators:
 Consideration of different pillars of sustainability within one indicator
 Aggregation of a weighted mix of individual indicators

 Problems: • weights
• expression of different indicators on the same units
• informative value of an aggregate indicator with very
heterogeneous subindicators

− Examples for Indicators

 One-dimensional indicator: 1. Ecological Footprint
 Multi-dimensional indicators: 2. Genuine Savings

43
1. Ecological Footprint (Global Footprint Network)
Translation of the ecological impact of human activities into the area of land that is necessary to
reproduce consumed resources and to absorb the generated pollution.

Sustainability criterion:
Biocapacity (available area) – ecological footprint (used area) ≥ 0

Captures (with limitations) the development of natural capital

→ indicator for strong sustainability

Not captured in the ecological footprint

− Depletion of non-renewable resources
− Pollution that is not absorbed/degenerated (e.g. heavy metals, toxic waste, radioactive
substances)

44
Ecological Footprint: Comparability of different areas
Different areas of land have different biological productivity depending on
− its use (e.g. forests compared to grazing land) and
− its location (e.g. in different countries)

→ Conversion of available land in normalized „global hectares“ (gha) [1gha = 1 ha of average global
biocapacity]:

Consumption-oriented indicator
Captures natural resources that are required to allow consumption in a specific area (independent of
where the consumed goods are produced!)

45
Ecological Reserve/Deficit

Global Footprint Network (2018)

46
47
48
2. Genuine Savings
Comprises savings of an economy in extended form (= net investment in the aggregate capital stock):

Net investment in physical capital (traditional savings concept)

+ investment in other types of capital (human and social capital)
- Pollution and net depletion of natural resources
= Genuine Savings

Sustainability criterion: Genuine Savings ≥ 𝟎𝟎

Captures the development of the aggregate capital stock

→ used as indicator for weak sustainability

49
Example for Genuine Savings indicator: "Adjusted
Net Savings" (World Bank)

World Bank (2006)

50
Adjusted Net Savings (2019)

World Bank (2021)

51