Thinking in the Margins
I have spent the better part of my first week of Laidlaw thinking about margins. Crucial decisions in environmental economics are often made using marginal analysis, a concept central to my research.
Let’s take a simple thought experiment.
Say you have zero adorable polar bears in your life, and you find one adorable polar bear. As adorable as the polar bear may be, that first one will be worth a lot more to you than the hundredth or millionth polar bear.
With every additional polar bear you find, the satisfaction you gain from each one decreases. The marginal utility of finding another polar bear declines as you find more adorable polar bears.
This concept of decreasing marginal utility is useful for explaining how groups of people across time may value units of goods differently depending on how their consumption patterns change.
Before we continue, have a polar bear…
Economists project increased economic growth in the long run, and thus average consumption per person may increase in the future. This means that future generations may value extra units of consumption differently, perhaps less, than we do today. In other words, their marginal utility of consumption may decrease as consumption increases over time. Why is this important? Because how elastic, or sensitive, marginal utility is to these potential changes in consumption represents one factor that helps economists understand how to find a number called a social discount rate for utility.
Economists spend a lot of time arguing about how to calculate this particular number, and I have spent a large part of my week reading about their disagreements.
What is a discount rate?
Let’s take another thought experiment, but first…
If you’re not allowed to gain interest on your money, would you choose to have 100 pounds now or 100 pounds in 10 years?
What about 70 pounds now or 100 in 10 years?
A discount rate, similarly to a normal interest rate, discounts a future amount of utility (or income) back to present value. Governments use it to decide how much to invest now in projects to mitigate climate catastrophes, in order to see returns in the future. Discounting the far off future is a difficult task particularly when you add in deep, unsettling uncertainty due to catastrophic risk. Nevertheless, it is crucial to environmental economic analysis because current policy is what may matter most in future years.
By this point, you may be thinking that these concepts of marginal utility and discount rates seem abstract and a bit useless if you are not an economist or an aspiring one. So why have I chosen to explain them to you? These concepts are not only the core foundations for my research in economics, but they have also shaped how I think about margins in my own life and in my approach to work. They have helped me understand how to prioritize tasks in a more economically driven way. This is something that I believe Laidlaw scholars in any discipline can learn from, so I thought I might share a little moment of discovery from week one.
This week, some of those aforementioned papers on discount rates were reminding me that I have not (yet) taken mathematical economics, and I was wishing I had a bit more mathematical wisdom to pull me through tough times (hour six at the library). It was time to humble up, and go back to basics, and scour the library shelves for a textbook.
Upon turning to chapter nine in Further Mathematics for Economic Analysis, I found a quote that I wish I had found in minute one instead of hour six.
‘A person who insists on understanding every tiny step before going to the next is liable to concentrate so much on looking at his feet that he fails to realize he is walking in the wrong direction.’
-I Stewart 1975
I usually pride myself on scrupulous research. ‘Don’t turn the page without looking up all of the words you don’t know. Finish your first book before you start the next’. Week one has taught me that this approach is not going to cut it. The mantra must change to ‘Prioritize, don’t obsess’. Evaluate the marginal utility of your next step, the next hour, next page on a difficult topic. Don’t mindlessly take tiny steps without evaluating what you have to gain. Think about discount rates! The work you put in today may be worth more to you tomorrow. Longer strides. Look up.
Thank you to my supervisor Professor David Ulph for your teaching and advice, and thank you to Lord Laidlaw for this incredible opportunity to spend my summer researching a topic I care deeply about.
Hammond, P., Seierstad, A., Strøm, A., & Sydsæter, K. (2006). Further Mathematics for Economic Analysis. Harlow: Financial Times/Prentice Hall.
Pearce, D., Ulph, D. (1999), “A social discount rate for the UK”, in Pearce, D.W. (Ed.), Economics and the Environment: Essays on Ecological Economics and Sustainable Development, Edward Elgar, Cheltenham, pp.268-85.