What is the price elasticity of demand for "green" products such as electric cars? We know that there are lots of different companies hard at work on producing electric vehicles. As they conducted their R&D, they must have formed a subjective guess concerning what price they would sell their first generation of vehicles for. No company enjoys losing money.

Now, Nissan has shook up this nascent green market by promising to offer their vehicle to consumers for $25,000 (net of a generous government subsidy). So Nissan will be paid $32,500 for each vehicle and each consumer who buys "a Nissan Leaf" will pay $25,000 and taxpayers such as my wife will finance the subsidy of $7,500. Given the fixed cost of designing the first generation of these vehicles ; companies must have an expectation of the scale of sales to lower their average fixed cost of production. For details on Nissan's Leaf see this and this .

This raises an interesting advertising issue. Up until its safety problems, the Toyota Prius was "the green car". Now with electric vehicles all the rage, how will these vehicles compete? Simply on price? A price war won't benefit the producers but consumers will be happy and so will environmentalists as people trade in Hummers for Leafs. Advertising firms could get rich here as they use their clever tricks to try to "help" consumers to distinguish between these various vehicles.

If there are 10 different makers fo electric vehicles, how will each search for its own market niche? From their perspective, each would like a small monopoly so that they can charge a price markup over their cost of production (i.e earn real profits). But, in a globalized economy --- will this happen?

In this morning's print edition of the New York Times Arts Section (don't ask why I read it), I stumbled upon a brief mention that Freakonomics will be turned into a documentary and this Dubner blog entry fleshes this out.

Now that the door is ajar, what other economics research will squeeze through? General equilibrium would be a hard sell.

1. I could imagine that a good documentary could be made about Andrew Lo's or Ariely's work showing "behavioral man" getting worked up and making "un-Spock" like decisions at the peak of some emotional high.

2. I could imagine an insider documentary showing a typical day at a University of Chicago Seminar where the speaker quickly realizes that he doesn't have property rights at his own seminar. The audience would have to decide whether they root for David or Goliath.

3. I could imagine Bill Easterly touring one of the Millenium Villages and walking with Jeff Sachs as they debate what are the true keys to economic development in front of the cameras.

4. I could imagine a new round of "Simon vs. Ehrlich" as the NBER's Energy and Environmental Economics group debates some Peak Oil folks. I would invite Stephen Holland to play a key role here.

5. Like the Odd Couple, we could pair unlikely buddies such as Eugene Fama and Paul Krugman and watch them drive across country together. On the way, they would discuss each other's work and ask tough questions.

I'm trying to think about which of my papers and books would make a good documentary. The answer is "Climatopolis" but we must wait until the September publication for me to convince you of this.

Ignoring uncertainty, households and firms should do projects that have a positive net present value . Many empirical economics papers such as this one examine how a household's decisions are affected by its initial wealth. For example, suppose that you must choose whether to attend UCLA or work at Starbucks. Ignoring financial aid and assuming you cannot get a loan from parents or a bank, if you do not have $12,000 in the bank --- you cannot attend UCLA because you can't finance the tuition payment. If this young person would have simply kicked back and drank a lot of beer at UCLA then this is not a big social loss but if this young person would have discovered a cure for baldness by studying at UCLA then guys like me would be forever grateful. Economists would call her "liquidity constrained" if attending UCLA is a net present value > 0 investment but she cannot do this "project" because she can't pay the upfront tuition.

Now, here is my point. Environmental economists haven't paid much attention to liquidity constraints as an impediment to the "green economy". But, the company "Solar City" appears to be focusing on reducing upfront costs of going green through a "leasing" program for solar panels. Details are here . As I understand it, a solar system for a home can cost $20,000 to $30,000 upfront. This is a big investment. Part of Solar City's business plan is to give you a financing plan to pay an annual rate (like rent) for your solar panels. A Behavioral economist would say that this backloads pain and makes the price less salient as you spread it out. A Chicago economist would want to know what is the implicit interest rate solar households are paying for this.

Permit me to give you an example;

Suppose I want to sell you my book Climatopolis today and I offer you two ways to pay for it:

Option 1: give me $100 now

Option 2: give me $10 a year forever. In an economy in which the market rate of interest is 5%; we know that the Net PDV of option #2 = 10/.05 = $200 .

So what? The consumer sees the low price of "$10" as an annual flow and the smart company collects $200 in present value rather than the measly $100.

Now if this large a profit opportunity exists then free entry predicts that Solar City will face competition as entry takes place.

But, their business model raises an interesting empirical question --- as financing on annual flow basis becomes easier; will more middle class households adopt solar? In part this depends on how "sexy" they view it, how much they believe it adds to a home's resale value, and what they believe is the price path for electricity in their community.

The other interesting piece of information I see at Solar City
http://www.solarcity.com/residential/solar-lease.aspx is the company's attempt to reduce risk for the installing household. They offer a money back guarantee and promises of skilled installation and repair.

Similar issues arise for small firms. As they consider how energy efficient to be, how do they finance costly upfront investments? Are there financing arrangements to share the risks and the returns with deep pocket investors?

Is there a possibility of a nascent literature on corporate finance meets environmental and energy economics?

When I was a teenager, I liked Kurt Vonnegut books such as Slaughterhouse Five . So, when the NY Times writes an article about slaughterhouses I read it. The Times reports a funny story. Apparently, there are gains to trade. There are a number of free market hippies seeking to get rich selling "local food" (pigs, sheep that they raise on their rural farms) to sophisticated nearby big city fancy restaurants. The problem is one that Tony Soprano could appreciate. Who "whacks" the sheep?

Apparently there is something called a "Slaughterhouse" that transforms a living creature into something that Don Trump would want cooked medium rare. The "problem" is that a byproduct of the suburbs/rural interface and the rise of environmental concerns is a classic NIMBY issue. Nobody wants a slaughterhouse in their community. They must smell bad, polluter the water and appear to be "low class". So, the irony here is that the local pig growers must drive their pretty hog hundreds of miles to find the "local" slaughterhouse. This adds to costs and chips away at the argument that the local food is low carbon.

The NY Times article is weak on discussing why the slaughterhouse industry is contracting in the areas such as Vermont and Deleware County in Upper New York State.

To investigate this issue, I used google to find this article in Farming Magazine. This issue claims that food safety regulation and inspection is raising the cost of doing business by small slaughterhouses and they are responding by shutting down.

Given my interest in economic geography, it is an interesting question how we choose where to site necessary but nasty economic activity such as power plants and slaughterhouses.

Berkeley's Lucas Davis has taught me about the determinants of the siting of power plants but I can't find a similar paper on the determinants of the siting of slaughterhouses. So, I'm no dope. I appreciate that the slaughterhouse wants to be close to the rural demanders of its services (the pig growers) but as exurban development takes place does this sharply contribute to shutting down these "rural factories"? This strikes me as a nice example of a dynamic coase theorem at work. As exurban areas experience population density increases and rising per-capita incomes (as they become suburbs); it is probably efficient to shutdown nasty rural activity but then the anti-carbon justification for growing "local food" makes less sense.

This map of North Carolina Hog Farms makes my point. But, I want to see that map at multiple points in time to see how the probability that any given hog farm (and related slaughterhouses) are shutting down over time in relation to suburban growth.

Harvard's Rob Stavins asks "Who Killed Cap and Trade?". The NY Times is asking the same broad question .

The recession has not helped the push to internalize the carbon externality. Hummer drivers, meat eaters, electricity consumers, cement makers are all not eager to face higher input prices at a time when their earnings are down. Matt Kotchen and I have figured out a credible strategy for measuring this "recession chills the ardor for Carbon policy" effect and we should have a serious NBER paper ready in 2 months or so.

Last year, Mike Cragg and I served up our basic answer to Rob Stavins' question in this NBER paper . In that paper and in this better version of that paper, we document that there is clear evidence that Congressional representatives from high carbon, poor, conservative areas are not going to support such legislation. Our statistical model can be used to identify the "marginal fence sitting" representatives who Nancy Pelosi would need to form a coalition of the willing on carbon. For generations, environmental economists have spoken about the coase theorem (when property rights are well defined --- bargaining will take place and an efficient allocation of resources will emerge --- intuitively --- a vegetarian never ends up with a meat pizza) --- so in this case; liberal wealthy states such as California should make side payments to the West Virginia type states to encourage their leaders to vote pro-green. These aren't "bribes" to politicians. These would be transfers to the people of such states to help them cope under the new anti-carbon incentives that would be built into cap and trade.

So, you don't have to be a Nobel Prize winner to think through the narrow self interest of each of these Representatives and Senators from such states as Indiana and Missouri. Each will ask himself; "what are the benefits of adopting a carbon cap and trade and what are the costs?" Do the benefits to my district exceed the costs?

Of course, both are very difficult to quantify; on the benefits side -- it has become clear that the U.S enacting cap and trade is unlikely to set off a "chain reaction". Imagine if China and India said that they would match any regulation we sign, that would be a "chain reaction". The Congress may believe that the rest of the world can't credibly commit to "match" the U.S. If other nations do not respond to our unilateral actions, then given that we are 25% of world emissions --- a major 50% reduction by us does dent global emissions but not for long as China and India's share of emissions grows.

On the costs side, we need economists to generate credible estimates of how household well being for heterogeneous households will be affected by pricing carbon. This is a classic incidence question. In low carbon states such as California, households will face less of this carbon incentive then in a humid, sprawling, large home, coal fired power plant region. California could make side payments to these states' leaders to compensate them for the anticipated higher costs brought about by carbon legislation. I don't know if this was discussed.

Permit me to end with some optimism. Assume that California's AB32 is implemented and that over the next 10 years that California's innovation sector makes serious directed green technological progress --- these new "google" ideas can be adopted by the rest of the county and this lowers the cost of complying with a cap and trade mandate. Such substitution possibilities will make leaders in Missouri more willing to sign such legislation. Under this scenario, cap and trade will make a comeback when its anticipated price tag falls. Now will this be too late? Will Jim Hansen and 350 ppm and the general doom and gloom caused by climate change already have taken place? I do not know.

Shifting gears, the Stavins piece mentions that greens need booms and disasters to achieve political goals. Folks should read my 2007 paper in the Journal of Risk and Uncertainty that discusses the "silver lining of disasters" point using Congressional voting data before and after 5 major environmental disasters.

Over the last month, reporters have been calling academic economists and asking important practical questions. Health economists have been asked how the Obama health care legislation will affect the budget deficit. Environmental economists have been asked how California's climate change mitigation legislation (AB32) will affect the state's economy? Will this legislation accelerate California's growth or prolong the current recession?

On health care reform, here is the CBO's attempt to crunch the data.

Here is the California Air Resources Board's updated economic analysis of the scoping plan.


"The Climate Change Scoping Plan provides California’s blueprint for reducing its greenhouse gas (GHG) emissions to 1990 levels by 2020 as directed by AB 32, California’s Global Warming Solutions Act of 2006. In approving the Scoping Plan, the California Air Resources Board (ARB) directed ARB staff to update the analysis of the economic effects of implementing the Plan. That updated economic analysis, documented in this report, profited from consultation with members of the Economic and Allocation Advisory Committee (EAAC), appointed by California Environmental
Protection Agency (Cal/EPA) Secretary Linda Adams and ARB Chairman Mary Nichols. EAAC consists of top economists, business and financial leaders."

Subtle thinkers should note that the Lucas Critique is highly relevant in both cases. "The Lucas critique, named for Robert Lucas′ work on macroeconomic policymaking, supports that it is naive to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data."

In both the health reform case and the California carbon mitigation case, I don't believe that economists have been completely honest about the fundamental uncertainty lurking here. The policy makers are getting ready to run two major policy experiments but economists can't be confident that we know what will happen next. The main reason for this is that we are not strong at predicting how technological change's "direction" is affected by major government policy shifts. We also do not know the key "elasticities" of how behavior will change as the policies shift incentives. For example, in the case of health care reform --- will the uninsured, who will now be covered by insurance, take better care of themselves and how healthier will they be?

In economic policy discussions, economists are used to being asked smaller questions such as; "if we raise the minimum wage from $7 to $8 will this have unintended consequences?" Compare this "small" policy change with the major incentives changes bundled into the health care bill and the carbon mitigation legislation. When modest economists shrug and say, "I don't know" what will happen next? The vacuum is filled by "policy entrepreneurs" (recall Krugman's term) who fill the void by providing the politicians with convenient numbers that they would not be able to defend in an academic setting.

Despite my deep reluctance to support the use of macro CGE models to judge the effects of California's carbon regulation, I am confident about its likely medium term beneficial effects. My optimism is based on the regulation's core focus of "green incentives". If credible (and not repealed by future Republican Govenors), this regulation will nudge households and firms within California to adapt and make choices to decarbonize. This will stimulate induced innovation and the next generation of "green products" through the home market effect. The rest of the U.S and the rest of the world will gain from California being a first mover. I do think that the Obama Administration should think about rewarding California for being such a voluntary guinea pig.

As I get older, I now am starting to believe that the "Nelson/Winters" ugly line about the evolutionary nature of capitalism is the first order issue here.

Static efficiency doesn't interest our students. They care about distribution. Dynamic efficiency --- how we improve our standard of living by innovating our way out of the major challenges we face (cancer, climate change) remains the key question for determining capitalism's benefits.

Today is a big day in California environmental politics. The Air Resources Board has released its new economic report providing details of its best predictions concerning the likely impact of this important regulation. Details are posted here:
http://www.arb.ca.gov/cc/scopingplan/economics-sp/economics-sp.htm

Jim Sweeney and I published an editorial today in the Los Angeles Times. You can find a draft of that piece at
http://www.today.ucla.edu/portal/ut/analysis-of-cost-of-greener-california-155823.aspx. We argue that AB32 offers some benefits and that we need careful economic analysis of its true micro economic effects.

I was also happy to see this US News and World Report article discussing my work on the impact of natural disasters. http://news.yahoo.com/s/usnews/20100324/ts_usnews/whynaturaldisastersaremoreexpensivebutlessdeadly

Returning to AB32, I spoke to many different reporters today and I always said the same thing;

1. I don't love "macro models"
2. I do believe that this regulation is beneficial because of how it will change firms and households incentives and this MICROECONOMIC incentive change will spur green innovation and help the California economy in the medium term.

A smart writer from the San Diego Union Tribune pushed me asking about free riding. He asked why California must be the Guinea Pig? Why can't we free ride like everyone else (given that the rest of the world failed at Copenhagen to sign a global deal). I pushed back that California, Oregon and Washington are large enough together to form a home market effect to push the green economy regardless of what the rest of the nation is doing. But, upon reflection -- I do think he is right that President Obama should think about offering a "green carrot" to California for taking this costly first move for the social good of the "big green economy". I will return to this point in a future post.

Will the Obama Health legislation increase political opposition to immigration? I see an expansion of coverage for 30 million people in the United States. This must be an income transfer to this group and this means that taxpayers will cover this. Now, I do hope that preventative medicine will reduce this group's demand for costly emergency care but I do not know of a NBER quality health economics paper carefully documenting this optimistic claim.

Let's assume that the expansion of health care insurance coverage for the uninsured is an income transfer. If immigrants are over-represented in this group (or if this is even perceived to be true), will political opposition to immigration rise? The economics literature on the determinants of redistribution would say yes. Read the Alesina and Glaeser book. If you don't have time to read that, then read this . The ugly fact that emerges is that we are not generous when the recipients "look different" than us. Now, how big of a tax price will we collectively face because of this legislation? The CBO doesn't know the answer to this and I don't believe a word of the "scoring" that they do. Health economists will have plenty to do over the next couple of years.

Now, I am a full fan of immigration. In previous blog posts, I have argued that the U.S should auction off 3 million passports a year.

what is the core logic here? Immigrants tend to be poorer than average and younger than average. These groups are over-represented among those who don't have health insurance. Friends of Fox News have already noted this fact .

On March 29th, I make my comeback as an environmental economics teacher. To prepare for this big day (and the 200 registered students), I'm vanishing and heading up to Berkeley for 10 days of solar panels and Prius watching and no blogging. I will be thinking about this WSJ piece that debates the consequences of the Congress' refusal to pass credible anti-carbon legislation. The article argues that there is a huge amount of "green investment" sitting on the sidelines and not happening because of the fundamental uncertainty about what are the "rules of the game".

This is a key application of the deep ideas of investment under uncertainty. Robert Pindyck outlines these ideas in this very nice survey piece. In a nutshell, when uncertainty about the direction of public policy increases --- a business will delay making an irreversible investment and wait until the uncertainty is resolved. While this is individually rational, it can be socially costly if there is a core challenge (i.e climate change) that grows more dangerous with further delays in battling it.

Imagine if a block of adjacent liberal/green states such as California, Oregon and Washington formed a "Regional Green Trading Block" where they collectively enacted the equivalent of California's AB32 .

This collective effort would feature a large number of people (perhaps 45 million) and cover a large land area. If this "Green Region" committed to only purchasing new high average MPG vehicles and demand a large share of electricity to be produced from renewables, then this consumer push would attract the green investment that the WSJ claims is sitting on the sidelines. The old "home market" effect from International Trade would kick in as this 45 million person region would be large enough to sell to even if the rest of the nation continued to side with Dick Cheney.

The Green Home Market Effect would even offer a convenient story to convince my liberal/green region that our next great export base (forget movies) will be shipping green products to the rest of the nation and China.

In this sense, a green trading bloc could be a building block to achieving a national carbon policy. In this case, the green region would pre-commit to be the guinea pig and if the learning by doing effects actually exist for "green" products then the rest of the country will be happy to adopt them after the learning takes place in my West Coast Lab (i.e California, Oregon, and Washington). My friends in Canada, if you want to join this coalition of the willing, you are welcome. The greater the size of the home market --- the greater the economic opportunities for suppliers.

Economists seek to explain and predict human behavior. We believe that people can change their behavior as they receive "new news". Other research fields implicitly assume that people do not change our behavior and thus they predict the future using naive statistical extrapolation methods. The recent swine flu epidemic offers an interesting case study. A new NBER Working paper titled "Public Avoidance and the Epidemiology of novel H1N1 Influenza A" by Byung-Kwang Yoo, Megumi Kasajima, and Jay Bhattacharya (NBER Working Paper No. 15752
February 2010
http://www.nber.org/papers/w15752.pdf) investigates this important issue.

"In June 2009, the World Health Organization declared that novel influenza A (nH1N1) had reached pandemic status worldwide. The response to the spread of this virus by the public and by the public health community was immediate and widespread. Among the responses included voluntary avoidance of public spaces, closure of schools, the ubiquitous placement of hand sanitizer, and the use of face masks in public places. Existing forecasting models of the epidemic spread of nH1N1, used by public
health officials to aid in making many decisions including vaccination policy, ignore avoidance responses in the formal modeling. In this paper, we build a forecasting model of the nH1N1 epidemic that explicitly accounts for avoidance behavior. We use data from the U.S. summer and the Australian winter nH1N1
epidemic of 2009 to estimate the parameters of our model and forecast the course of the epidemic in the U.S. in 2010. We find that accounting for avoidance responses results in a better fitting forecasting model. We also find that in models with avoidance, the marginal return in terms of saved lives and reduced infection rates of an early vaccination campaign are higher."

As individuals take costly actions (how costly?) to protect themselves (hand washing) their small mutinees against the public health threat help to protect us all from infection. A serious public health research question should investigate how different households (white, black, Hispanic, Asian of different ages and education levels) each respond to the common threat of epidemic. Who is most responsive? Do their local residential communities suffer less disease risk because of these individual responses? Which individuals and communities engage in the least epidemic "self defense"? How can we encourage such communities and individuals to be more pro-active?

In this age of air travel and globalization, there must be the variation in the data to explore the geography of contagion and the interesting aggregation patterns of which geographical areas suffered little from the epidemic versus which areas and demographic groups suffered greatly.