The Handbook for Economics Lecturers

3. Teaching sustainability in a standard module

The first available way to integrate sustainability into an economics curriculum is to simply tack it on as a subject at the end. However, in practice such topics tend to get dropped, or not included on exams. A more effective way to integrate sustainability – though requiring greater co-operation from staff – would be to use examples from sustainability. Table 1a outlines an introductory economics course, taking in microeconomics and macroeconomics, into which applications to sustainability have been added. The table presents possibilities for inclusion: tutors can pick and choose topics depending on how deeply they wish to explore sustainability. The sustainability topics do have some logical progression, but they could be taught independently.

Table 1a: Introductory economics course

Microeconomics
Topic Sustainability augmentation
Positive/normative distinction, etc. Multiple ethical bases: triple bottom line (see Elkington, 1997)
Scarcity; economic problem Scarcity: absolute versus relative
Markets: supply and demand Carbon markets; oil market (could include ‘peak oil’)
Demand theory; elasticity Effect of a tax on petrol; road charging
Theory of returns and costs End-of-pipe technology and costs1
Theory of the firm Increase of resource/raw material/energy costs
Market structures Joint profit maximisation – fishing and maximum sustainable yield (see Box 2)
Market failure Externalities of pollution
Micro policy Carbon rations, petrol taxes; optimal amount of pollution
Macroeconomics
Topic Sustainability augmentation
Circular flow of income Circular flow extended to include biosphere (see Box 2)
Macroeconomic objectives Sustainability as an objective; an extra trade-off
Economic growth Sustainable development; alternative measures of well-being, such as Index of Sustainable Economic Welfare (ISEW), Happiness indices, and the Happy Planet Index (HPI); environmental Kuznets curve (see Box 7)
Keynesian macroeconomics Green stimulus packages (see New Economics Foundation, 2008)
Unemployment Green jobs
Inflation Price of green products; finite resource cost inflation; backstop technology (see Box 8) as a response to inflation
Money demand and supply Green economics treatments of money as debt; carbon as a currency; local currencies
Monetary policy Green quantitative easing
Fiscal policy Green stimulus packages; carbon and pollution taxes
International trade Transport costs; the Kyoto protocol; localism versus globalism
Exchange rates Carbon trading markets

1 End of pipe technology refers to adaptations of existing plants to reduce pollution.

Some of the sustainability topics included are easy to include, whereas others require more ingenuity. Examples of the former are the discussion of the effect of a tax on petrol as an example of elasticity; the carbon market as a market to study; and the treatment of pollution externalities. On the macro side, the effect of natural resource costs on inflation, the use of fiscal policy for green stimulus, and the measurement of standards of living are also simple to introduce. In the category of more difficult topics would be those that require conceptual shifts, such as the discussion of multiple ethical bases, joint profit maximisation, and sustainability as an economic objective (see above; and see Box 2 below).

Box 2: Renewable resources

Theories of the exploitation of renewable resources are covered in most standard environmental economics texts covering natural resource economics. Students are interested (at least to some extent) in the escalating price of fish and chips and this represents a good context for discussing the management of fish stocks and behaviour of fishing enterprise under different regimes.

Information has an important role in the sustainable harvesting of renewable resources (see for example, Clark, 1990). If those exploiting the resource act in their mutual long term self-interest and have full information about the impact of various levels of harvesting on stock levels, then the risk of over-exploitation is removed and the maintenance of carrying capacity is more likely. It is fascinating that traditional hunter-gatherer societies often had such information systems embedded in their cultures, reinforced by a system of beliefs and rituals.

The figure below shows the outcome of restricted access to a renewable resource, for example, where the number of operators is restricted through a licensing system.

The figure above shows the outcome of joint profit maximisation where hunters or fishing enterprises act to limit their activity (effort) so that the maximum harvest relative to effort is achieved. As effort (E) increases, the harvest rate (H) initially increases but peaks at the maximum sustainable yield (MSY) where stock density and food supply allows the maximum rate of reproduction. Additional effort causes stocks and hence population density to fall and increasing difficulty in mating. Joint profit maximisation (at Em) requires barriers to entry and restriction on individual enterprise effort. Good information on fish stocks, catches, etc. will enhance stability. With open access, additional effort is made, stocks fall and the reproduction rate falls so that profit is zero.

In the diagram, W = wage rate, P = price per unit of catch, TPB = total private benefit, TPC = total private cost.

Top tip

Utilise the extensive range of software packages available. See Section 7 for some examples.

All would involve the commitment of some time by the tutor. Even more challenging (as hinted at by the discussion of multiple ethical bases) can be ventures into other disciplines. Examples are the extended circular flow of income (see Box 3 below), end-of-pipe technology and its effects on costs, green treatments of money (see Scott Cato, 2008: ch. 5), ‘green’ quantitative easing, and discussions of geological theories, such as peak oil. Whether or not and how these get taught will depend on how much time is available, the willingness of the tutor, and the availability of relevant supporting resources. As in Table 1b below, the topics above can be delivered either as an entire suite, or more likely, selected to enrich a standard module, alongside examples from other relevant broad topic areas.

The extended circular flow model has a natural resource stock located at the centre and the flows of materials and services to and from the household and productive sectors indicated by arrows. An approach that has proved successful is to present the conventional circular flow in a lecture and ask where the natural environment and ecosystem services are. It is conventional for students to answer that these are contained within land. Ask the class for examples of the inputs that come from land. Usually students ignore the ability of the natural environment to provide waste assimilation services. They also ignore the waste assimilation and amenity services provided to households. That omission is the justification for making these ecosystem services explicit by adding to the diagram as above.

Clearly at the introductory level there is plenty of scope for examining sustainability issues. At the intermediate level, this is also true. In this case we shall discuss an intermediate microeconomics course with sustainability material included. One could of course also construct an intermediate macroeconomics course augmented for sustainability. The issues of integration, resourcing, specialist knowledge required and time constraints are present as in the case of the introductory course. In some respects they are even more acute because the technical level of the material is higher. In other respects, though, integration of sustainability is just as easy, if not easier. Table 1b outlines an intermediate microeconomics course augmented for sustainability. As above, although it is possible to deliver all of these augmentations, that is not necessary. The suggested discussion topics can be inserted individually into a conventional course.

Box 3: Extending the circular flow of income

The circular flow of income is a foundational tool in economics, and is typically found in introductions to macroeconomics. The typical circular flow model presents flows of income, expenditure, goods and services between groups of economic actors. The version below is highly simplified, collapsing government and import sectors into ‘businesses’.

Table 1b: intermediate microeconomics course

Topic Sustainability augmentation
Consumer theory ‘Economic man’ vs. ‘Eco-man’ (see Becker, 2006); willingness to pay (WTP), willingness to accept (WTA); cost benefit analysis (CBA)
Analysis of choice under risk and uncertainty Problem of non-probabilistic (Knightian) uncertainty? Question the value of the expected utility hypothesis under uncertainty
Analysis of investment appraisal and long-term decision making Assumptions made? Discounting and the environment? Precautionary principle
Isoquant theory Questioning the nature of capital; natural capital; the shape of isoquants
Theories of the firm Alternative goals: business ethics
Labour markets Basic income schemes
Market structure and efficiency OPEC and oil prices
Game theory Climate change negotiations and compliance –see discussion of classroom games.
Price discrimination Peak flow pricing
General equilibrium analysis Welfare effects of climate change
Public goods and merit goods Environmental impact evaluation
Externalities and their internalisation Pollution and its abatement

For example, once students have discussed consumer theory, it is an easy step to discuss the notion of an eco-man (cf. economic man) whose concerns with sustainability may override utility from consumption of some goods; or for whom preferences are lexicographic in favour of sustainably-produced goods. Also, indifference curve analysis can be used to discuss willingness to pay and willingness to accept (see for example, Perman et al., 2003: ch. 12). Notions of compensating and equivalent variations help illustrate cost benefit analysis. The topic of valuation is discussed further in Box 3, which also discusses cost benefit analysis; and the software package CBA Builder (Wheatley, 2010) is discussed in Section 7.

Top tip

CBA Builder, like any tool, takes practice to master. Ask students to perform multiple evaluations.

For some of the topics shown in Table 1b the sustainability aspect is very clear: for example, general equilibrium, public and merit goods, and externalities are often taught anyway using environmental examples. For some of the other aspects it is also fairly trivial to introduce sustainability. For instance, OPEC is often used as a case study in oligopoly. The sustainability angle could be extended to discussing broader aspects of OPEC strategy, such as linking production to reserves. The theory of peak oil could be discussed at this point. Sustainability also lends itself to a discussion of price discrimination. An interesting exercise in price discrimination is to present students with apparent examples of it – such as fair trade versus other coffee, feed-in electricity tariffs, organic versus non-organic food – and discuss whether (and why not) these are true examples. Modelling climate change treaty negotiations and compliance could also be a good vehicle for teaching game theory. It is easy to use a simple Prisoner’s Dilemma to discuss the likelihood that one country would renege on climate deals; and then discuss why this analysis might explain why climate deals are difficult to negotiate. It is also easy to incorporate discussions of sustainability into the topics of investment appraisal and long-term decision making. Clearly, as discussed in Box 3, discounting is a crucial feature of valuation of ecological objects, and of CBA. Some students may appreciate the chance to discuss concrete cases of a non-financial nature; others may wish to discuss what discount rates ought to be. Ackerman (2009) provides an illuminating discussion of discount rates from the viewpoint of sustainability. More difficult for economics tutors to discuss might be questions of the nature of capital (and therefore substitutability); and non-probabilistic uncertainty. Yet, uncertainty of this type is pervasive in sustainability questions. Sensitivity analysis can assist us in imagining future scenarios but it is instructive for students to consider what they would do when they simply do not know future risks.

Box 4: Valuation

Cost benefit analysis (CBA) is an ideal point at which to introduce the valuation of environmental assets. CBA has been criticised for failing to evaluate environmental impacts, merely describing them in physical units. Over the past 30 years, methodologies for evaluation in money terms have been evolving, although these are not widely used as they have proved expensive and unreliable. Nevertheless, it is often argued that it is better to have some monetary evaluation rather than a physical measure that is not included in the net present value and thus easy to ignore. The application of valuation techniques has been given a boost recently by attempts to evaluate ecosystem services and 'green infrastructure' by central and local government (see for example www.greeninfrastructure.org.uk).

Total economic value of natural capital

Discussing total economic value (TEV) with students as an introduction to evaluation encourages reflection on the meaning of value in economics. TEV is made up of use value and non-use values. Use value can be direct where, for example, a lake is used for fishing, or indirect, where it provides the setting for a pleasant walk. Non-use value is usually divided into a number of categories representing different ways in which a natural asset may bestow value:

  • Option value arises from the retention of the asset for possible use in future, for example moorland which might be used for grazing or forestry in future.
  • Quasi-option value is based on a possible use which may arise in future due to new knowledge about the asset. An example would be the Amazon Rain Forest where many plant species remain to be catalogued and some might yield a valuable drug for medical use.
  • Existence value derives from an emotional attachment people feel for natural assets that acquire some cultural significance, even though there may never be an opportunity to experience the assets at first hand. Threatened species such as whales, rhinos and tigers evoke strong feelings as do iconic landscape features – Everest, the Danube, the Grand Canyon. Subsets of existence value include heritage value (the desire to preserve the asset for future generations) and vicarious use value (associated with contemplating the enjoyment of the asset by others).

Evaluating environmental impact

Most development incurs environmental costs as a result of the destruction or degradation of environmental assets or by causing pollution. For example, building a new road will interfere with natural drainage, cause pollution of watercourses, and act as a barrier severing wildlife habitats. It will result in noise and congestion to local communities in the construction phase. It will continue to have an impact on amenity by causing noise and pollution subsequently. In many cases, the impact will reduce the use value of the asset. Direct use may be associated with a marketed output and the reduction in this is the basis for evaluating impact. Indirect use may also be marketed where entrance fees are charged. Where there is no money transaction, there are three main methods of evaluation:

  • Contingent valuation method (CVM) elicits values from a representative sample of an appropriate population by describing a context where an environmental asset is (usually) destroyed. Respondents are then asked how much they would be willing to pay (WTP) to preserve the asset or how much they would be prepared to accept in compensation (WTA) for the loss. Unique among valuation methods, CVM can capture all the components of TEV.
  • Travel cost assumes that the expense of travelling to visit an environmental asset is a good proxy for a price for the benefits of the visit. By surveying a sample of visitors to the asset and collecting travel cost and other socioeconomic data, it is possible to generalise to the total population of visitors and construct a demand curve for the benefits flowing from the asset. The method only captures use value.
  • Hedonic pricing uses the variation in the prices of dwellings or remuneration levels associated with different environmental conditions as a source of evidence of the WTA for tolerating those conditions. The most frequent application has been the variation in house prices with proximity to some nuisance (such as aircraft noise from an airport) or some environmental asset (such as a riverside location). Applying the technique requires the collection of house price data in the area, together with house and neighbourhood characteristics that might also have an influence on price. Econometric estimation of a house price function will allow the component of the price associated with the environmental attribute of interest. This is the basis for deriving a WTP or WTA associated with the attribute. Again, this method only captures use values.

Benefit transfer

As more studies of the values of environmental assets and conditions are completed, a database of valuations can be built up. Increasingly, it becomes possible to use the results of previous studies as the basis for valuation in new projects without having to carry out an asset valuation from scratch. The UK repository of valuations is available at http://www.hm-treasury.gov.uk/d/green_book_complete.pdf .

A critique of valuation methods

Detailed descriptions of the methods briefly outlined above can be found in most standard texts on environmental economics. These usually include a listing of the shortcomings of the methodologies with more detail on operationalisation. Suffice it to say that, as the number of studies have built up, the range of values for similar assets has been disturbingly wide suggesting serious reliability issues.

Introducing valuation to students

This is a very rich area for exploring issues in applied economic methodologies and for discussing underlying theoretical issues. As an introductory exercise, groups of students can be asked to choose an environmental asset to value and then be given 15 minutes or so to sketch a valuation methodology they might apply. Each group then describes their methodology and this leads to some interesting discussion of problems and challenges.

CBA (see Box 5) is an excellent application for students to consider. It has clear policy implications and usefulness and deals with concrete examples. CBA is used in a variety of contexts within government. It also serves as an excellent pedagogical tool, as it can stimulate discussion about what and how to measure objects, whether or not they are amenable to measurement and, if not, how to deal with them. CBA Builder (Section 7) is a good tool for teaching and for students to master Excel. It is therefore useful on any applied microeconomics course. Further, attitudes to CBA are also one of the division points between environmental and ecological economists: the latter are sceptical of CBA and at best favour cost-effectiveness analysis.

Box 5: Cost benefit analysis (CBA)

Investment appraisal (IA) is a good starting point for introducing CBA. This establishes the basic cash flow foundation, the distinction between one-off capital and recurring current expenditures and discounting. IA can be presented as capturing the private costs and benefits of a project. The introduction of external costs and benefits transforms IA into CBA.

Presenting a case study helps to emphasise the relevance of the subject. An example taken from a study of tourism development in Minorca is shown below:

The study compared the provision of 1000 bed spaces in an extensive villa style development with concentrated high-rise resort development. The students tend to think that villa style development is more sustainable and the IA shows that it provides a much greater private NPV. However, the external costs that are included in CBA show that the high-rise concentrated development generates a greater social NPV. This is largely due to the very great infrastructure cost of providing utility services and access to developments spread all over the island, together with the greater land take, energy consumption and water demand associated with villas each with their own swimming pools and air conditioning systems.

Of particular relevance to sustainability is discounting. There is an argument that intergenerational equity implicit in the resource based view of sustainability demands a discount rate of zero. A valuable discussion of the theoretical basis of discounting can be based on issues of inflation, risk and time preference.

Students can construct their own CBA using CBA builder (see Section 7).

CBA leads naturally into the evaluation of environmental impacts (see Box 4) The potential contribution of CBA to deciding macro policy priorities has been illustrated recently in the Stern Review (Stern, 2006), in which it was the key methodology for assessing the benefits of intervening to reduce carbon emissions and thus to reduce the likelihood of further global warming.