A Preview of Chapter Six of my New Book

The good news for you is that my book only has 16 chapters so pretty soon you won't be reading another preview of my Fundamentals of Environmental Economics book.  Chapter Six is a vanilla chapter with a few twists.  Given that the environment represent a set of public non-market goods, many environmental economists spend their lives devising clever ways to figure out how much do people value such goods.  We can only judge the benefits of environmental regulation if we have some idea about how much different individuals value pollution reduction.

Similar to other standard texts, I discuss hedonic real estate examples and contingent valuation.  Unlike other texts, I actually teach the reader some basic econometrics to show how estimates of a home price hedonic provide tight bounds on a household's willingness to pay for non-market public goods.

But, then the chapter gets exciting.  I introduce Harry the Hippo.

"In academic economics, a growing number of empirical papers use what is called a “field experiment” design in order to test hypotheses. In this section, I explain in detail how to conduct such a study and provide a relevant application for young environmental economists.  The point of this example is to teach students how to estimate demand curves and how to learn about people’s willingness to pay for environmental goods. 

            Suppose that there is a zoo in Los Angeles.  The zoo is home to a single creature called Harry the Hippo.  The zoo spends $9000 dollars a year to feed and protect Harry.  The zoo has no sources of revenue and has no benefactors or government support. If the zoo collects less than $9000 each year in tickets to see Harry then the zoo will close.   The zoo hires an economist named Kahn to help them figure out what is the demand curve for visiting Harry.   Kahn tells them that from the Law of Demand he knows that the demand curve slopes down for seeing Harry.  In English, this means that if the Zoo charges more for a ticket to see Harry that fewer people will show up.  Kahn tells the zoo that while he knows the sign of the slope of the demand function (it has a negative slope with respect to price) he does not know the demand curve’s intercept (i.e at what price per ticket would demand be zero) and he doesn’t know the slope of the demand curve.  Kahn’s ignorance annoys the zoo keeper who is about to fire Kahn, when Kahn mentions that while he doesn’t know the shape of the Los Angeles Harry the Hippo demand curve, he has an idea for how collect the data to estimate this demand curve.  The Zoo Keeper tells Kahn to go ahead and run his field experiment.   Permit me now to tell you my experimental design."

I show how to use a randomized zoo ticket price design to estimate an aggregate demand curve and then I use this demand curve to solve for the revenue maximizing ticket price. I calculate the consumer surplus zoo attendees will gain.   So, unlike most books I've seen I integrate consumer theory, environmental economics and field experiments and basic statistics into one 5 page example.    Not bad for a $2 book?

Amazon Fresh and the Rise of the Consumer City

I'm starting to think that Amazon's Pat Bajari (their Chief Economist and my old co-author) spends his days thinking of new ways to lure my household to spend 100% of our disposable income at Amazon.  The lucky people of Seattle and Los Angeles (who live in certain "select zip codes") now have access to Amazon Fresh.   Since we are an Amazon Prime household who lives in Los Angeles, we have been able to purchase some great food products that are delivered to our door in a funky green bag.

"Free same-day and early morning delivery on orders over $35 of more than 500,000 Amazon items, including fresh grocery and local products.

AmazonFresh is now available in the Los Angeles area in select zip codes as a free 90-day trial to Amazon Prime members. After your free 90-day trial, your membership will automatically upgrade from a Prime membership to a Prime Fresh membership and you will be charged $299 for the next year and annually after that. This includes all the benefits of Prime, plus access to AmazonFresh. Your current Prime membership will be refunded on a pro-rated basis when you upgrade to Prime Fresh." 

When Glaeser, Kolko and Saiz wrote their "consumer city" paper, did they anticipate this new product?  Note that an Internet Company (Amazon) is making living in a great city (Los Angeles) even better as its new Amazon Fresh saves us time shopping and now we have a greater access to an increased variety of products such as wild boar.  Whole Foods in Westwood hasn't offered us that!    This case of the Internet making cities even stronger is an old point that Glaeser and Gaspar made years ago.  

A Preview of Chapter Five of Fundamentals of Environmental Economics

Chapter Five of my new Fundamentals book  is titled; "Where Do People Choose to Live Across and Within Cities?".  The chapter begins by introducing the key concept of revealed preference.  Intuitively, economists learn about your desires and priorities from the costly choices that you make.

The joint decision over what city and neighborhood to live in plays a key role in determining your household’s exposure to a variety of environmental indicators ranging from climate, to access to the coast, to water and air pollution.  Unfortunately, there is no "free lunch". If you seek to live in a city that scores high on all set of "green city" criteria such as clean air, clean water and access to green space, you are going to pay high rents (think of San Francisco).  

The chapter then turns to locational choice within a specific city.  So consider San Francisco.  Within San Francisco, which neighborhood do you choose to live in?  The typical person will know her budget constraint and where she will be working.  This information allows her to calculate her commute time from each possible neighborhood to her job.  This person will recognize that each community has strengths and weaknesses and she will seek out that community that is both affordable and best meets her priorities.  

Based on this logic, I discuss how differential pollution levels across different communities within the same city affects who chooses to live there.  By the "no free lunch" argument, rents will be lower in the areas where pollution is worse.  In the simple economy I present,  there are two types of people who seek apartments. One type is called "Superman".  Superman suffers no health problems when exposed to pollution.  The other type of people are called "Average Joes".    The Joes do suffer when they are exposed to pollution and they know this.  I show that in this case, the Supermen will choose to live in the cheap polluted part of the city. Why?   The rent is low and they like that and the pollution doesn't bug them (they are superman!).  The Average Joes will choose to live in a clean and expensive community.  

Now the interesting point here is that a public health researcher who ignores this residential sorting based on one's type (this essential heterogeneity) would conclude that exposure to air pollution is good for you!  Why?  The supermen never get sick and live in the high pollution area while the Joes do get sick and live in the low pollution area.  A statistical researcher who naively calculates the correlation of pollution and sick days would find a negative correlation and jump to the causal claim that pollution is good for you!  The mistake here is that we never observe the counter-factual of how much sicker the Average Joes would have been had they lived in the high pollution area.  This example highlights how my book teaches readers about environmental economics and econometrics at the same time!

The Chapter goes on to teach readers the famous Tiebout Sorting of how a diverse population self segregates into more homogeneous communities.  

I then teach the readers about how to conduct an environmental justice analysis and the use of GIS data.  I base this on my 2001 paper. 

The chapter ends by discussing in this age of the 1% and the 99% the differential in access to excellent urban environmental amenities between the rich and the poor. This issue arises in California where the rich own the homes near the beach and they try to privatize the beach sand as an extension of their property while this land is supposed to be in the public domain.

A major theme of my book is the exploration of economic incidence.  As America's cities grow "greener", does everyone benefit from this quality of life progress or do the rich disproportionately gain because they own more of the land that is more valuable because the objective quality of life has improved?

Some Bad Economics About The Future of Miami

This will be a blog post about durable capital, expected present discounted value calculations and endogenous depreciation and the efficient markets hypothesis.  My point is that only real nerds will want to read this.  But, I will be talking about $60 Trillion Dollars.  This article  offers the following "teachable moment".  Here is a quote:

"And what of Miami? It contributed $263 billion to gross domestic product in 2010, according to the Bureau of Economic Advisors. Caught between rising seas to the east and the Everglades to the west, the city is doomed to drown.
Abandoning Miami means not only moving or abandoning the businesses who create its gross domestic product, but walking away from its pricey real estate, its roads, hospitals, schools and infrastructure. The cost of relocating its people needs to be calculated both in dollars and in heartbreak. But if you ask people to estimate the cost of abandoning Miami, you get blank stares. It’s as if the language to ask the question hasn’t been invented yet.
“It is not difficult to envision much larger costs, [i.e. $60 trillion] given the potential larger and more abrupt warming [the more abrupt the warming, the more costly it is to try to adapt] that the authors calculate,” says Mann. And it’s not difficult to imagine that there are costs we haven’t even begun to imagine. And when you multiply those costs, city after city after city, suddenly $60 trillion becomes a very realistic and frightening number." 

A recent "big think" paper in Science posited that when the Arctic Icecap melt that this will cost us at least $60 trillion in damage.   To make this salient, climate activists such as Mann are saying that we will lose Miami and this will have horrible impacts on our economy.   This makes no sense.  The economic activity that currently locates in Miami will move to higher ground.  Nobody claims that Miami is an inherently productive place so that the $263 billion dollars in economic activity could only be generated there.  Miami will reform in another piece of the U.S.

You don't have to be Acemoglu to ask the following questions;

1.  what is the probability that Miami vanishes within the next 75 years?  The smaller this number is the lower is the expected PDV of damage.
2.  How many years into the future is this event likely to take place?  We discount future benefits and costs using the real market rate of interest.  The further in the future this damage is likely to take place then the lower are the costs.
3.  Isn't all urban capital infrastructure depreciating over time?  Our buildings, roads, hospitals --- -everything in cities doesn't last forever.  The usual life of a building is 60 years. If we anticipate that Miami is going to flood in the year 2060, then in the year 2025 we stop maintaining Miami buildings and we don't build new buildings and other placed based infrastructure.  Instead, we build new infrastructure on higher ground and the firms and people in Miami engage in an organized retreat.  This rebuilding activity stimulates the economy (think of Europe rebuilding after World War II).
4.  Who loses from the retreat from Miami?  The land owners who owned the land just as the "new news" that Miami will be doomed in the year 2060 was announced and digested.  These land owners "overpaid" for the Miami land because the price when they paid reflected the present discounted value of the rental stream they would earn out into the infinite future but if Miami will be flooded after the year 2060 then there is no such rental stream and home prices today will reflect this expectation and will drop as the new news is incorporated into current asset prices (this is the efficient market hypothesis under rational expectations).  As home prices drop, poor people would move in.  Note that the poor who move in gain from access to cheap short run land.  

Assets such as the Miami Dolphins will move to another city.  The University of Miami will let its campus go and find a new place in Florida to do business.  This is adaptation.  Those geographic areas that have a competitive advantage in the face of climate change (i.e they are on higher ground) will command a price premium and land prices and economic activity will rise there as a new Miami will take root.

So, the doom and gloomers would only be correct if the capital stock lives forever. In this case, valuable assets that will always be valuable would have been built in the wrong place (Miami) and cannot be dragged to higher ground. In the real world, all assets fall apart over time (look at the senior faculty at many econ departments for evidence!).  As Miami's assets depreciate, rational investors will not invest in improving them because they will recognize the short investment horizon.

With all of this said, is Miami doomed in the face of climate change?  I would say no.  The engineers and urban planners and land owners in the city need to take a sober look at identifying which parts of their city are the most likely to be resilient in the face of climate shocks.  The city should encourage densification there.  The insurance industry should price future premium to encourage economic activity to relocate there.  If the people of Miami choose not to retreat, then the housing stock and electricity grid and storm sewers will need to be upgraded to make it more resilient in the face of shocks.

A Preview of Chapter Four of My New Amazon Kindle Book

Whether the price of my book is $0 or $2 tomorrow, you will still gain some consumer surplus if you buy my new "classic" Fundamentals of Environmental Economics.   In this post, I will talk about the book's chapter four titled; "Where Do Dirty Factories Locate"?

Erin Mansur and I recently published a paper on this topic in the Journal of Public Economics.  

My starting point is that many urban pollution externalities exist because dirty industrial activity takes place in a geographic location filled with people.   Why are the people living there? Why did the firm choose this location and why does it continue to produce there?   Unlike many undergraduate texts, I introduce the reader to a discrete choice problem namely does a polluting firm locate in Boston, San Francisco or Dallas?  This cost minimizing firm recognizes that these three possible locations differ with respect to local wages, local real estate prices, distance to final consumers and they differ with respect to their pollution regulation.  A firm will know its production needs. For example, a firm that needs a lot of land to produce may choose to avoid the place where land is expensive.  Alternatively, a firm that pollutes a lot may avoid the high regulation area.  I teach the reader how to calculate the total cost of production for a given firm in each possible location and we spot the cost minimizing choice.

I then walk the reader through  the "reverse engineering" problem of "given that a firm has chosen a specific location to produce, what must be its priorities for how it tradeoff various attributes of a city (i.e how important are low wages versus low  energy prices in determining whether the factory moves to a given city).  Why does this model matter? In this day and age when everyone is asking why Detroit is dying, why don't firms moves there?  A good model of firm locational choice is relevant for predicting which cities will grow and which cities will experience an influx of pollution from pollution intensive industries.  In joint work with my co-authors in China right now, we are using these same models to explore the migration of industrial activity from coastal cities to poorer western cities.

Returning to chapter 4 of my book, once I finish the domestic locational choice example --- I then turn to the threat of offshoring.  If the U.S EPA introduces stringent environmental regulation, what types of firms can credibly threaten to move abroad to a "pollution haven"?     So, U.S regulation can reduce U.S pollution by reducing pollution per unit of industrial activity (a technique effect) or by unintentionally displacing production to other nations.  The "Goldilocks" goal is to make regulation tight enough to achieve the former goal while not making too tight so that "we lose jobs".   How the U.S regulators navigate this potential mine field requires an ability to engage in fine tuning and to assess which jobs are the most "footloose".

At the end of the Chapter, I return to one of my favorite themes.  Deindustrialization in the U.S Rust Belt, in Eastern Europe and now in China's major coastal cities has dramatically improved local environmental quality.

The Chapter ends with a small model that Gary Becker would like.  It builds on his work with Ehrlich on Self Protection.

Industrial Environmental Negligence and Endogenous Effort by Firms

Consider an oil company that can take costly precautions that will reduce the probability of an oil spill. Such oil spills (when they occur) cause significant environmental damage.  I study how the expectation of a large monetary fine for an oil spill incentivizes the for profit company to take more ex-ante precaution (i.e invest more to minimize the probability of a spill).  So, credible punishment leads to good behavior!  All parents know this and I show how in a simple calculus example to solve for the optimal effort by the firm and how this effort is an increasing function of the ex-post expected fine that the company would have to pay if there is a spill.  

So, this chapter highlights several ways to reduce industrial pollution externalities using an economics approach.  Again, while this book is a textbook it also isn't a textbook --- anyone can read it and it will make you think! If you disagree, I will give you your $2 back!