Economics
An Introduction & Review of
Some Basic Economic Principles
for Joules To Dollars
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Frederick Soddy
• Nobel Prize in Chemistry in 1921 for his work on radioactivity
• Inspired the field of ecological economics
• Became dismayed with the Chemistry as a discipline about the time of WWI
and turned to economics, specifically political economy
• Ideas were generally discredited at that time, but in fact he was an early
proponent of abandoning the gold standard, market-determined foreign
exchange rates, fiscal policy as a tool for stabilizing the macroeconomy,
and government agencies responsible for collecting and reporting economic
statistics.
• Also argued against fractional-reserve banking.
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
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Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Circular Flow Chart of the Macroeconomy
A Traditional View
Income
Factor Payments
Factor Pmts
Private Saving & Borrowing
Households
J2$
Markets for Factors of Production
Taxes Net of
Transfer Pmts
Borrowing
& Saving
Financial
Markets
Govt Borrowing
Taxes Net of Subsidies
Government
Govt
Purchases
Borrowing
& Saving
Imports
Rest of
the World
Exports
Consumption
Investment
Market for Goods & Services
Firms
Revenue
Costanza, R., June 2001. Bioscience, Vol. 51, No. 6
Model of An Ecological Economic System
Positive Impacts on Human Capital Capacity
Restoration,
Conservation
Education, Training,
Research
Institutional Rules,
Norms, etc.
Building
Complex Property Rights Regimes
Consu mption
Individual | Common | Public
Natural Capital
Human Capital
Social Capital
Manufactured Capital
Limited Substitutability
Between Capital Forms
Solar
Energy
Well Being
(Individual & Community)
Ecological
Services /
Amenities
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(Based on Changing,
Adapting Preferences)
Wastes
Economic
Production
Process
GNP
Goods &
Services
Evolving
Cultural
Norms &
Policy
Inves tment
Negative Impacts on All Forms of Capital
Decisions about taxes, community spending, education, science and technology,
etc., based on complex property rights regimes
Waste Heat
Soddy & Energy Economics
• Interpretive questions?
• Why were Soddy’s ideas dismissed by academics, policy makers,
and financiers?
• Is debt a bad thing when it’s tied to energy efficiency or
improvements in ecosystem services?
• “Energy and the U.S. Economy” was written at a time of energy
crises; how might the relationships between energy and the
economic performance be different today?
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Review of
Microeconomics
Glossary of terms, concepts, and
solution methods
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Comparing Benefits & Costs
• Assume a linear world
• Typically, people will purchase less
of a good or service (including
ecosystem services) the higher the
price
Suppose at $5/bag…
$ Price
$25
Consider buying “nut”
coal to use in your
wood stove
You’d buy 10 bags
Demand
But if the price were $25/bag you
wouldn’t buy any coal
$5
10
Quantity
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Total Benefits
• Economists typically use your total
willingness to pay to define total
benefits
• We add up the amount you’re
willing to pay for the first,
second, … , ninth and tenth bags
of coal
We calculate the area under the
demand curve
$ Price
$25
(½ x 10 x 20) +
(5 x 10) = $150
$5
10
Quantity
Market Demand
• Market demand curves for consumer goods and services are
simply the sum of individual demand curves
• Note that while our theory tells us that demand depends on
price: Q = f(P)
• We graph the inverse form of the demand curve: P = g(Q)
• We do this because of an assumption that price adjusts in
order to equilibrate demand with supply, i.e., price
determines quantity
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Total Costs
• Suppose the cost of producing a
bag of nut coal looks like this
• In general, total cost will be
equal to variable costs plus fixed
costs
• Total variable cost is the sum of
the marginal costs
• Let’s assume zero fixed cost
• So total cost will be the sum of
the marginal costs
$ Price
$15
10
Quantity
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Net Benefits
$ Price
• Net benefit is the amount by which
benefits exceed costs
• The area under the demand curve
that lies above the cost (supply)
curve
Net
Benefit
Quantity
Cost-Benefit Analysis
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• Most of the decisions you make involve weighting costs against
benefits
• Opportunity Cost plays an important role in these calculations
Defn: that which we forgo, or give up, when we make a choice or a
decision
• Costs and Benefits generally accrue over time
• Dynamic, rather than a static, decision
• Examples: Colby’s bioimass plant, new solar array on the top of
the alumini/development building, purchasing a new car,
insulating your home.
Dynamic Analysis
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• Which is worth more: $100 today or $100 tomorrow? Why?
• Inflation erodes the purchasing power of money
• Plus, $100 today represents an opportunity to ‘invest’ …
• … earning a rate of return [e.g., interest on savings] …
• … and thus increasing your purchasing power in the future
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Present Value
Suppose you put your $100 in a bank account earning 10% interest annually
One year from now you’d have $110 in your account: 100×(1+.10)
The value today of the $110 you’d realize a year from now is $100 [110/(1.10)]
Suppose you left the money in your bank account for two years, earning 10%
interest in each year
• After two years you would have $121 [100×1.10×1.10]
•
•
•
•
• The present value of the $121 you’d realize in two years is $100
121
1.10 2
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Net Present Value
• The present value of a one-time net benefit received 𝑛 years from
now is:
𝑁𝐵𝑛
𝑃𝑉 𝑁𝐵𝑛 =
1+𝑟 𝑛
• The present value of a stream of net benefits
𝑁𝐵0 , 𝑁𝐵1 , ⋯ , 𝑁𝐵𝑛 is:
𝑛
𝑁𝐵𝑖
𝑃𝑉 𝑁𝐵0 , ⋯ , 𝑁𝐵𝑛 =
1+𝑟 𝑖
𝑖=0
• Where 𝑟 is the appropriate interest rate
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Discounting the future
• The process of calculating the present value of a future
[net] benefit is also known as discounting
• In this context, 𝑟 is the discount rate
𝑃𝑉 𝑁𝐵𝑛
• What about inflation?
• 𝑟 is the real interest rate: nominal minus inflation
𝑁𝐵𝑛
=
1+𝑟
𝑛
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Colby’s Biomass Facility
Scenario A: Base Case
Utility Relocations
General Site and Utilities
Building
Equipment
Soft Costs
$
$
$
$
$
FY2011
550,000
373,000
2,779,000 $
1,698,500 $
1,367,000
FY2012
$
PV @ 5.5% $
6,017,500 $ (5,280,500)
10,450,312
FY2041
2,779,000
1,698,500
Grant
$
(750,000)
Debt Proceeds
$ (10,495,000)
Debt Service Expenses (5.5%, 30 year)
$
737,000
Total Payments
…
…
$
737,000
…
$
737,000
Return to Supply &
Demand Analysis
Equilibrium
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Static Equilibrium
• Notice that no one is willing to supply
coal at $5 per bag
• At $5/bag there exists excess demand
• In most situations this will cause an
increase in the price of coal
• Similarly, at $25/bag there is an excess
supply of coal
• In most situations this will cause a
decrease in the price of coal
• Price will adjust to resolve excess
demand and supply
$ Price
$25
Pe
$5
Qe
Quantity
Elasticity
• We measure the responsiveness of demand to
changes in price using the elasticity
• We say that a good is inelastic if a change in
price has very little effect on demand
• Elastic goods and services are those for which
small changes in price have a large impact on the
quantity demanded
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%Δ𝑄
𝜂=
%Δ𝑃
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Inelastic vs Elastic
$ Price
$ Price
Inelastic
Elastic
DP
DP
DQ
Quantity
DQ
Quantity
How do you remember the difference?
nelastic
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lastic
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Modeling Supply & Demand
• Demand function - determinants
•
•
•
•
+ - -
Price of the good or service
Price of substitutes & compliments
Income
Preferences (stochastic term)
• Supply side
•
•
•
•
Price
𝑆 𝑃; 𝑊, 𝐴
Pe
Price of the good or service
Factor prices (wages, energy costs)
Advertising/Marketing
Unanticipated events (stochastic term)
- + -
+
𝐷 𝑃; 𝑃𝑠 , 𝑃𝑐 , 𝑌
Qe
Quantity
Moving along a curve vs shifts in a curve
• Changes in the quantity demanded of a
good or service that result from a change
in its price are reflected by
reequilibrating movements along a
demand curve
• Similarly, changes in the quantity supplied
resulting from changes in the price of a
good or service are reflected by
movements along the supply curve
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Price
𝑆 𝑃; 𝑊, 𝐴
Pe
𝐷 𝑃; 𝑃𝑠 , 𝑃𝑐 , 𝑌
Qe
Quantity
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Exogenous changes
• Changes in factors determined
outside our model will redefine the
(P, Q) relationship resulting in a new
demand or supply curve
• We draw our demand/supply
relationships for pre-determined
values of our explanatory variables
• Consider a ceteris paribus increase
in income from Y0 to Y1
Price
𝑆 𝑃; 𝑊, 𝐴
Pe
𝐷 𝑃; 𝑃𝑠 , 𝑃𝑐 , 𝑌0
Qe
𝐷 𝑃; 𝑃𝑠 , 𝑃𝑐 , 𝑌1
Quantity
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Equilibrium adjustment
• At the prevailing price, Pe, there
exists excess demand for this good
• This will put upward pressure on the
price
• Higher prices attracts more supply
• And reduces demand
• The price will continue to rise until
the excess demand is gone and the
market reaches a new equilibrium
Price
𝑆 𝑃; 𝑊, 𝐴
Pnew
Pe
𝐷 𝑃; 𝑃𝑠 , 𝑃𝑐 , 𝑌0 𝐷 𝑃; 𝑃𝑠 , 𝑃𝑐 , 𝑌1
Qe Qnew Qexd
Quantity