Ecological Economics: Principles and
Applications
Chapter 2:
The Fundamental Vision
Herman E. Daly and Joshua Farley
Chapter Overview
o The Whole and the Part
o Optimal Scale
o Diminishing Marginal Returns and Uneconomic Growth
o A Paradigm Shift
o The Circular Flow and Linear Throughput
o Say’s Law: Supply creates its own demand
o Leakages and Injections
o Linear Throughput and Thermodynamics
The Whole and the Part
Standard Economics sees the Economy as the WHOLE system.
Ecological Economics sees the Economy as part of a larger ‘Earth System’
Open, Closed, and Isolated Systems
Open System: Matter and Energy Flow in and out.
(Example: A human being)
Closed System: imports and exports Energy only.
(Example: The Planet Earth)
Isolated System: Neither matter nor Energy enter or leave.
(Example: hmmm tough one – The Universe?)
Pre-Analytic vision of Neo-Classical Economics is that there are no
opportunity costs associated with perpetual growth of the
macroeconomy; or , there is no such thing as uneconomic growth.
Optimal Scale
Optimal scale is not strange to microeconomics.
Question: At what level of production does one
stop making widgets?
When Marginal Costs = Marginal Benefits
The ‘When to stop rule’. Strangely, there is no
such rule in the Macroeconomic world view.
Why? Because there are no opportunity costs
for growth when the ECONOMY is viewed as
an isolated system. This world view ‘works’ in
an empty world. However, in a full world the
opportunity costs of growth become so large
that we have uneconomic growth in which
welfare actually goes down.
Welfare is a psychic entity.
Matter and Energy are physical entities.
“Neglecting the biophysical basis of
economics gives a false picture. But
neglecting the psychic basis gives a
meaningless picture.”
Diminishing Marginal Returns
&
Uneconomic Growth
The preanalytic vision of
Ecological Economics is expressed
in the figure to the right. Stanley
Jevons asked the question:
‘When does the effort of working
begin to exceed the value of the
wage to the worker?’
An Ecol Econ analogous question:
‘When does the cost to all of us
displacing the Earth’s ecosystems
begin to exceed the value of the
extra wealth produced?’
‘b’ – where we want to be
‘e’ – grim life at carrying capacity
‘d’ – the end of the world as we
know it and we feel fine. 
The greatest good for the greatest number problem – See Garret Hardin Paper
A Paradigm Shift
Why do Neoclassical economists not see the problems
associated with ideas of the ‘Full World’, diminishing marginal
returns, and uneconomic growth?
1) They believe we are still in the ‘Empty World’ thus, MU is
still very large relative to MDU.
2) Technology will save the day preventing MDU from ever
becoming too large relative to MU.
3) The Paradigm problem – The Economy is simply not seen as
a subsystem of a larger ecosystem. The Economy is an
isolated system that can grow indefinitely.
Where conventional economics espouses growth forever,
ecological economics envisions a steady-state economy at
optimal scale. Each is logical within its own preanalytic vision,
and each is absurd from the viewpoint of the other. The
difference could not be more basic, more elementary, or more
irreconcilable.
Circular Flow Diagram & Linear Throughput
The Product Market sets prices for goods and services.
The Factor Market sets prices for land, labor, and capital.
Factor prices multiplied
By the amount of each
Factor per household is
The household income.
The sum of all household
Incomes is National Income.
The sum of all goods and
Services is National Product.
Nat. Product = Nat. Income
The above is axiomatic by
Accounting convention. Profit
is counted as part of national
income.
Question from text: ‘Would the equality (above) still hold if Profits were negative?
Where Profits = Value of Total Production – Total Factor Costs
Assumptions of Circular Flow Diagram
Say’s Law: Supply creates its own Demand
‘If you build it they will come’ …well, not necessarily.
For a long time, economists believed Say’s Law ruled
out any possibility of long-term and substantial
unemployment. The Great Depression put a damper
on that fantasy. The depression did convince a few of
these economists to change their mind about the
comforting ideas implicit in the circular flow diagram
(among these economists was John Maynard Keynes)
It is increasingly recognized that the circular flow
diagram is an oversimplification that fails to account
for significant ‘leakages’ and ‘injections’ that do not
necessarily balance one another.
Leakages & Injections
Example of Leakage
Taxes Paid to Government
Example of Injection
Government Spending on
Roads, Satellites, Military, Fish
and Wildlife, Police, Education,
National Parks, etc.
Things like imports, exports,
savings, borrowing, taxes, and
government spending
complicate the simplicity of the
original circular flow diagram.
Question:
By including leakages and
injections have we saved the
preanalytic vision?
What is really ‘flowing’ in the
Circular Flow Diagram?
Is it physical goods and services and physical laborers and land and
resources? Is it ‘Money’? Actually, because the preanalytic vision of
traditional economics is such that the economy is modeled as an isolated
system, the ‘flow’ must be called ‘Abstract Exchange Value’ because
even physical money is subject to the laws of thermodynamics.
When goods arrive to the households, the “soul’ of exchange value jumps
out of its embodiment in goods and takes on the body of factors for its
return trip to the firms, whereupon it jumps out of the body of factors
and reincorporates itself once again into goods, and so on.
What happens to all the discarded bodies of goods and factors as the ‘soul’ of exchange
value transmigrates from firms to households and back ad infinitum?
Does the system generate wastes?
Does the system require new inputs of matter and energy?
If not, then the system is a perpetual motion machine. Ain’t no such thang.
The Laws of Thermodynamics
Has anyone heard of
“Maxwell’s Demon”?
Paul’s Version of the laws of Thermodynamics
1) You can’t win. You can only break even.
2) You can only break even at absolute zero.
3) Absolute zero is impossible to obtain.
Thermodynamics Concepts Inventory
Image taken from “Thinking Physics” be Lewis Carroll Epstein (super brilliant book)
Those pesky 2nd Law guys…..
Question: A room has a refrigerator in it.
Can you cool the room by leaving the fridge door open?
Can we put the ‘Circular Flow’ diagram in its place?
“The circular flow vision is analogous to a biologist describing
an animal only in terms of its circulatory system, without ever
mentioning its digestive tract. Surely the circulatory system is
important, but unless the animal also has a digestive tract that
connects it to its environment at both ends, it will soon die either
of starvation or constipation. Animals live from a metabolic flow –
an entropic throughput from and back to their environment. The
law of entropy states that energy and matter in the universe move
inexorably toward a less ordered (less useful) state. An entropic
flow is simply a flow in which matter and energy become less
useful; for example, an animal eats food and secretes waste, and
cannot ingest its own waste products. The same is true for
economies. Biologists, in studying the circulatory system, have not
forgotten the digestive tract. Economists, in focusing on the
circular flow of exchange value, have entirely ignored the
metabolic throughput. This is because economists have assumed
that the economy is the whole, while biologists have never
imagined that an animal was the whole, or was a perpetual
motion machine.”
The Fallacy of Misplaced Concreteness
Alfred North Whitehead - “Do not mistake the map for the territory”
We cannot think without abstraction. All the more important,
therefore, to be aware of the limits of our abstractions. The
power of abstract thought comes at a cost. The fallacy of
misplaced concreteness is to forget that cost.
Pertinent Joke:
An economist, a chemist, and a physicist are stranded on a
desert island with no food. A palate of canned food washes
ashore……
The Hourglass Analogy linking the laws
of Thermodynamics to both renewable
and non-renewable Energy sources
Sunlight –
Renewable Energy
Infinite quantity
Fixed Flow
Fossil Fuels –
Non-renewable Energy
Finite Quantity
Variable Flow
Today, Humanity burns
400 years of Ancient
sunlight every 1 year.
Big Ideas to Remember
Whole and Part
Open, Closed, and Isolated Systems
Optimal Scale
Full world vs. Empty World
Diminishing marginal utility
Increasing marginal costs
Circular flow
Linear Throughput
Say’s Law
Leakages and Injections
Fallacy of misplaced concreteness
Entropy hourglass
Measures of throughput volume
Laws of Thermodynamics
…In sum, Americans waste or cause to be wasted nearly
one million pounds of materials per person per year.
That’s a lot of Throughput to abstract from – to leave out of
You model. Question:
What should we focus on first – efficiency or frugality?