Life Cycle
Sustainability
Economics
Agenda
 How traditional economics
falls short of sustainability:
Tragedy of Commons &
externalities
 Possible Solutions:
 Triple bottom line accounting
 Emissions trading systems
 Life cycle cost analysis
 Including environmental
benefits in cost-benefit
analysis
Objectives
By the end of this unit, students should be able to:
1. Give an example of a Tragedy of the Commons and a
possible solution.
2. Give an example of pollution creating an externality and a
possible solution.
3. Compare advantages and disadvantages of triple bottom
line accounting.
4. Perform a life-cycle cost analysis.
5. Explain how the value of environmental benefits could be
determined.
Objectives
6. Perform a cost-benefit analysis that includes environmental
benefits.
Where traditional economics falls
short of sustainability:
The Tragedy of the Commons
 Dilemma first described by Garrett Hardin in
Science in 1968.
 Multiple individuals, acting independently, and
solely and rationally consulting their own selfinterest, will ultimately deplete a shared limited
resource, even when it is clear that it is not in
anyone's long-term interest for this to happen.
Tragedy of the Commons
 Assume a common-property
resource (exclusion is difficult and
joint use involves subtractability),
I.e., no property rights.
 e.g. pasture open to all
 Assume each herdsman tries to
keep as many sheep as possible on
the commons. They each try to
maximize gain.
Add those sheep!
 The rational herdsman
concludes that he or she
should add another sheep.
 And another…
 And another…
 And so does each herdsman
 “Ruin is the destination toward
which all men rush, each
pursuing his own best
interest…”
Possible Tragic Commons?






Where traditional economics
falls short of sustainability:
Externalities
 Externalities are the effect of a decision on a third
party that is not taken into account by the
decision-maker.
 Externalities can be either positive or negative.
 Examples of environmental externalities:
Possible Solutions to Tragedy of
the Commons/Externalities:
 Macro (national or state) scale:
1. Make it cheaper to treat than discharge
harmful pollutants: emission fees
2. Create emissions trading systems
 Micro (project/company) scale:
1. Use triple bottom line accounting
2. Conduct life cycle cost analysis
2. Quantify environmental benefits
3. Use a lower discount rate
Possible Macro-Scale Solutions:
Emissions Trading Systems
 Also known as cap and trade – market-based
 In order to pollute a specific amount (say 10 tons), companies
have to hold that number of allowances, or credits (10 tons of
credits).
 An overall regional cap is placed on the number of
allowances, to ensure good air quality. Cap can be lowered
over time to improve air quality.
 Companies that need to increase their emission allowances
must buy credits from those who pollute less.
 The transfer of allowances is referred to as a trade.
Possible Macro-Scale Solutions:
Emissions Trading Systems
 Economic incentive to reduce emissions: If polluters reduce
their emissions, they can sell the excess allowances at a profit.
 Economically efficient: Companies that can reduce their
emissions most cost-effectively will do so (theoretically) and sell
credits to companies that can’t reduce cheaply, achieving the
pollution reduction at the lowest cost to society.
 Technologically efficient: Companies are free to use any
means to reduce emissions (technology not mandated, as it
can be in other regulatory approaches).
Possible Macro-Scale Solutions:
Emissions Trading Systems
Examples:
 U.S. national cap-and-trade system for sulfur dioxide,
established under the Acid Rain Program of the 1990 Clean Air
Act (first cap-and-trade system in the U.S.)
 Texas banking & trading system for precursors that form the air
pollutant ground-level ozone (nitrogen oxides and volatile
organic compounds)
 http://www.tceq.texas.gov/airquality/banking/banking.html
 Baseline and credit program – each company has a regulatory limit.
Companies can bank and sell credits if they reduce pollution below their
regulatory limit.
 European Union trading scheme for greenhouse gases
Possible Micro-Scale Solutions:
Triple Bottom Line Accounting
 3 Ps of the triple bottom line:



 Triple bottom line accounting: expanding the traditional
reporting framework to take into account ecological and
social performance in addition to financial performance
 Company’s responsibility is to stakeholders, not only
shareholders. Requires a corporate commitment to social
responsibility.
 Who would stakeholders be?
Possible Macro-Scale Solutions:
Triple Bottom Line Accounting
 Realistic?
 Examples
 Shell Foundation’s involvement in South Africa (helping grow
local businesses to reduce poverty, reduce indoor air pollution,
schools for children)
 McDonald’s Corporation – Ronald McDonald House
 Others
Possible Macro-Scale Solutions:
Triple Bottom Line Accounting
 Example reporting frameworks:
 AccountAbility’s AA1000 standard, based on Triple Bottom Line
 Global Reporting Initiative’s Sustainability Reporting Guidelines
 Potential benefits?
 Orlitzky, Schmidt, and Rynes found a correlation between
social/environmental performance and financial performance
 Aid to employee recruitment and retention, particularly grad
students
 Reputation risk management
 Brand differentiation
 Disadvantages?
Economic Analysis: Methods of
Comparing Alternatives
 Present worth, annual payments, future worth
analysis
1. Life cycle cost analysis
 Break-even comparisons
3. Use a lower discount rate
 Rate of return (ROR), incremental rate of return
(IROR) analysis
 Cost-benefit analysis
2. Quantify environmental benefits
Possible Micro-Scale Solutions:
1. Life Cycle Cost Analysis
 In choosing among engineering project/product
alternatives, consider life cycle costs, or the total cost of
ownership over the life of the project/product.
 Also called “cradle to grave" or "womb to tomb" costs.
 Useful in present worth, annual payments, and future worth
analysis (methods that compare costs of alternatives), and in
break-even comparisons if benefits are not included.
Possible Micro-Scale Solutions:
1. Life Cycle Cost Analysis
 Phases of project/product life to consider:
 Planning
 Design
 Construction/production
 Operations
 Maintenance, renewal/rehabilitation
 Replacement or disposal
Possible Micro-Scale Solutions:
1. Life Cycle Cost Analysis
 What phases of project/product life cycle are traditionally
considered in alternatives analysis?
 Why might using full life cycle cost analysis benefit the
environment?
Possible Micro-Scale Solutions:
1. Life Cycle Cost Analysis
Example problem
Possible Micro-Scale Solutions:
2. Quantify Environmental
Benefits
Methods of comparing alternatives that include benefits:

Rate of return (ROR), incremental rate of return (IROR)
analysis

Cost-benefit analysis
In evaluating benefits, be sure to quantify environmental
benefits so they are not excluded.
Possible Micro-Scale Solutions:
2. Quantify Environmental
Benefits

Suppose that a city is doing a cost-benefit analysis for how
to use a piece of land. Two alternatives include:
1.
Allowing a developer to construct a shopping mall, and
2.
The “do nothing” alternative – leave the land as a forest.

How would you quantify the costs associated with each
alternative?

How would you quantify the benefits associated with each
alternative?
Possible Micro-Scale Solutions:
2. Quantify Environmental
Benefits
 Quantifying environmental benefits is typically difficult, so
environmental benefits historically have often been left out.
Ways to quantify environmental benefits:
 Surrogate markets
 Surveys
 Willingness to pay to visit a park
 Willingness to pay to use an HOV lane

Possible Micro-Scale Solutions:
2. Quantify Environmental
Benefits
Ways to quantify environmental benefits:
 Health benefits
 Air pollution caused by an industry may cause people to
miss work. A dollar value can be assigned to missed work
using salaries. Installing an air pollution control device
would have a quantifiable health benefit of fewer people
missing work.
 Health care costs attributable to air quality

 Other
Possible Micro-Scale Solutions:
2. Quantify Environmental
Benefits
 Cost-benefit analysis: Used to choose among engineering
project/product alternatives
 For each project alternative, calculate the ratio of benefits
to costs, with all benefits and costs adjusted for the time
value of money (typically everything is adjusted to present).
 Choose the option with the highest benefit-cost ratio or net
benefit
Possible Micro-Scale Solutions:
2. Quantify Environmental
Benefits
 PVB (present value of benefits)
 PVC (present value of costs)
 BCR (benefit cost ratio) = PVB / PVC
 Net benefit = PVB - PVC
Possible Micro-Scale Solutions:
2. Quantify Environmental
Benefits
Example problem – Cost-benefit analysis
Possible Micro-Scale Solutions:
3. Use a Lower Discount Rate
 Another way to consider sustainability in all
types of economic analysis: use a lower
discount rate
 A high discount rate implies a very low value on
the welfare of future generations
Summary
References
Allada, Venkat, “Introduction to Sustainable Practices in Design
and Manufacturing,” PowerPoint Lecture Slides, Missouri
University of Science and Technology, available at
http://www.templet.org/imm/en, assessed 3/2010
Callender, Craig. “The Tragedy of the Commons”, PowerPoint
Lecture Slides, Philosophy, USCD, accessed 3/2010.
“Emissions trading.” wikipedia.org/wiki/Emissions_trading,
accessed 3/2010.
Hardin, Garrett. ”The Tragedy of the Commons”, Science, Vol.
162, No. 3859 (December 13, 1968), pp. 1243-1248.