Economics and the Environment: A Signalling and Incentives Approach

Economics and the Environment: A Signalling and Incentives Approach

Economics and the Environment: A Signalling and Incentives Approach

Economics and the Environment: A Signalling and Incentives Approach

Excerpt

The idea that eventually led to this book was planted at my first reading of Nobel Laureate F.A. Hayek's classic paper 'The Use of Knowledge in Society', published in the American Economic Review in September 1945. Hayek explains that markets and government planning are alternative systems for coordinating people's use of resources. The effectiveness of coordination depends on the ability of each system to signal accurately information about people's wants and available supplies of resources, and on the incentives each provides for individuals to respond to the desires of others.

Introductory microeconomics textbooks commonly pay little attention to signalling and incentives, or to markets and government as alternative coordination systems. Signalling problems are overcome by assuming that decision makers have perfect information about others' wants and resource supplies. Decision makers are assumed to have appropriate incentives to respond to the desires of others. Given these assumptions, textbooks are able to concentrate on logical explanations of the decisions of consumers and producers in idealised markets, and the resulting market prices and quantities. The choice between market planning and government planning, perhaps the dominant political issue of the century, is generally set aside for later discussion. And this makes logical sense; with signalling and incentive problems assumed away, markets and government planning are equally effective ways of coordinating people's use of resources.

When we apply economics to the environment, this will not do. In core economics courses, there is some justification for introducing important analytical techniques using unrealistic assumptions which yield simple diagrams and equations. The complications due to imperfect knowledge, and the virtues and vices of market and government allocation systems, can be taught in later courses. However a large proportion of the students in economics courses devoted to the environment take little or even no other economics, and have little interest in economics per se. Many of these . . .

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