Appunti del corso di Economic Assessment of Urban Transformation (Prof. Caragliu)

ECONOMIC ASSESSMENT OF URBAN TRANSFORMATION (Caragliu)

Lesson: 10/3 - Slide1 “INTRO AND INTRODUCTORY PUBLIC ECONOMICS”

Many methodologies for the economic appraisal of urban transformations, both from the planner’s perspective ad well

as the private investor’s.

Reading list:

Campbell, H., and Brown, R. (2007). “Bene t cost analysis”, Cambridge (UK): Cambridge University Press.

• Rosen S. H., Gayer T., “Public Finance”, McGraw-Hill, ISBN: 0073511358.

• Capello, R. (2015). “Regional economics”, London (UK): Routledge.

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Esercitazione:

Scienti c paper, drafting short essay (3-4 pages, summarising the context of a scienti c paper)

May the 5th

Select a case study, nd the date, applied the method chosen.

Methods is chosen linked to the case.

Why some methods are better than other?

Summary

The course offers a wide perspective on many methodologies for the economic appraisal of urban transfor-

• mations, both from the planner’s perspective (collective bene ts of large urban transformation projects) as well as

from the private investor’s ( nancial return from large real estate projects).

The rst part of the course will deal with the Economics principles needed for a sound framing of appraisal tech-

• niques. This rst part will summarise the main theories explaining urban land rent formation and the main princi-

ples in public economics, with particular attention being paid to the two welfare theorems and the notion of ex-

ternality.

The second part will instead introduce the main methods for evaluating urban transformations, i.e. cost-bene t

• analysis, multi-criteria analysis, the hedonic price method, contingent evaluation, and Territorial Impact As-

sessment.

Lastly, in the third part of the course applied case studies will be presented, with an active role played by students

• carrying out empirical take-homes aiming at getting oneself familiar with the methodologies seen in class.

The nal goal of the course is to expose students to the various approaches to the evaluation of urban transforma-

• tions, applied to different case studies.

Given the advanced nature of the course, the course is oriented towards methodological applications, without

• however overlooking the economic theory needed in order to understand analytical techniques.

1. Fundamental theorems of Welfare Economics

2. Assumptions of the perfect competition model:

- Excludability

- Price system as a vehicle of market signals

- Price-taking behaviour

- Perfect information 1 di 16

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WELFARE ECONOMICS

Welfare: Quality of life

Why economic welfare increase in a given country?

Try to provide policy makers.

The object of welfare economics is the analysis of the main determinants of economic welfare in a given Country.

Researchers in this eld try and provide policy advice (consulenza politica) for Country and local authorities with the

nal goal to maximise economic welfare (Pigou, 1920)

“The economics of welfare” - Pigou (guidance book)

Three principles of UTILITARISM THEORY:

1. EVALUATING ALTERNATIVE CIRCUMSTANCES/CONDITIONS:

the only criterion for a correct evaluation is the welfare or satisfaction derived from people doing what they

prefer - Welfarism.

So, we evaluate alternative options on the basis of individual welfare level change.

(Valutare le opzioni alternative sulla base del cambiamento del livello di benessere individuale)

2. REASON FOR THE CHOICE OF ACTIONS: (Ragione/Motivazione per la scelta delle azioni)

Actions must be compared only in terms of the consequences they engender.

Consequentialism. It suggest that actions must be decided related to consequences that they (the actions)

create.

3. SUM-RANKING: Aggregation criterion must be the sum of individual welfare levels.

Policy option.

A fundamental criterion underlying the Utilitarism Theory is the principle of PARETO-EFFICIENCY.

(Ef cienza Paretiana: Nella ri-allocazione delle risorse => tutti guadagnano o rimangono uguali, ma nessuno perde)

Ef cienza paretiana (o Pareto-ef cienza).

ALLOCATION OF RESOURCES.

It is Pareto - ef cient a resource allocation that cannot be modi ed, such that the welfare level of everyone is

• improved. (even thou someone is damage by that resource allocation)

In other words, a welfare state is Pareto – optimal if and only if there is no alternative state of the world in which an

• individual is better off and no one is worse off.

Pareto ef ciency: an allocation is ef cient if there is no alternative allocation such that an individual is better off and

• no one is worse off.

Un’allocazione è ef ciente se non esiste un'allocazione alternativa tale che un individuo stia meglio e nessuno stia peggio.

Una situazione S Pareto-ef ciente (o ef ciente in senso paretiano) se non possibile accrescere il benessere di alcu-

no dei soggetti coinvolti, se non riducendo il benessere di qualcun altro di loro.

Una situazione Sʹ un miglioramento paretiano rispetto alla situazione S, se possibile trasformare S in Sʹ, dove il be-

nessere di almeno uno dei soggetti coinvolti maggiore in Sʹ che in S e nessuno ha minor benessere in Sʹ piuttosto

che in S.

Un miglioramento paretiano debole se nella nuova situazione il benessere, qualcuno dei soggetti coinvolti lo stes-

so di prima (ma non escluso che, invece, tutti godano di un miglioramento).

È invece forte se c’è un incremento di benessere per tutti i soggetti coinvolti.

Possiamo, pertanto, riformulare la de nizione precedente come segue:

Una situazione S Pareto-ef ciente se non esistono miglioramenti paretiani deboli rispetto ad essa. 2 di 16

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Fundamental theorems of Welfare Economics

The First Fundamental Theorem of Welfare Economics states/says that a competitive equilibrium is Pareto-

• ef cient (remember the de nition of Pareto ef ciency: an allocation (una quota) is ef cient if there is no alternati-

ve allocation such that an individual is better off and no one is worse off)

The Second Fundamental Theorem of Welfare Economics states/says that a Pareto Ef cient allocation can

• be obtained through a competitive equilibrium, with the intervention of the actor called Social Planner

(Local planner, Government, Policies, etc) and the actions of this person goes thru the market.

Social Planner, act toward re instating the equilibrium if some of the theorems was violating.

(It complements the rst theorem)

Taken together, these two theorems have important policy implications and provide the rationale for the free mar-

• ket and competition among economic actors.

Questi 2 teoremi presi insieme hanno importanti implicazioni politiche e

forniscono la logica per il libero mercato e la concorrenza fra attori

economici.

Then why do we have the public sector?

The main arguments justifying public intervention in the economy are twofold (duplici):

1. EFFICIENCY: is related to the aggregate level (livello complessivo) of economic activity.

2. EQUITY: is related to the distribution of the bene ts stemming from economic activity.

EFFICIENCY

Can an economy without public sector be ef cient?

An economy could not work without:

1. PROPERTY RIGHTS: (diritti di proprietà) Rules de ning legitimate possession.

(Hobbes: government as a form of social contract allowing men to avoid the anarchic state of nature).

2. CONTRACT REGULATION: (regolamentazione contrattuale) The set of rules governing trade (commercio)

(Fostering exchange eliminating uncertainties typically associated to economic transactions)

(Agreement so that people commit to perform an act that aims an economic transaction)

Accordi che vedono le persone impegnate a compiere un atto che miri a una transazione economica.

Imperfect competition: is a contract violation!

EQUITY

Many of the policy option we select, we have redistributive effects

—> Opportunity cost

• A further reason for motivating public intervention in the economy is related to income, opportunities, or

wealth inequality (just think of why public schools or social welfare programs exist).

• Therefore, whenever a government decides which policy must be undertaken, it faces two con icting goals:

1. Make the best use of available economic resources;

2. Pay attention to the distribution of these resources and to the effects of the policies.

No one is wanted to be left behind! 3 di 16

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Q: What relation exists between ef ciency and equity? The two are linked by a trade-off mechanism.

Problem: is there trade-off between these two objectives (ef ciency and equity)?

Esiste un compromesso tra questi due obbiettivi?

Are there other circumstances in which public intervention is justi ed?

Public intervention as a reaction to market failures (MF* exists whenever we have any assumption of the

• competition model is fully or partially violating) is justi ed on the basis of the principle of ef ciency.

A market failure exists whenever any of the of the assumptions underlying the perfect competition model

• is violated, and, as a consequence, the economy does not reach an ef cient allocation.

Before delving into the possible cases of market failure, we can get back to the question above. In the gure we

• have seen that European public expenditure over the last 20 years has constantly increased in terms of ratio to

GDP. How can that be?

Q: What are the two fundamental reasons for the government to step in in the economy? Explain how the two concepts differ.

R. The main arguments justifying public intervention in the economy are twofold: Ef ciency and Equity.

Ef ciency is related to the aggregate level of economic activity.

Equity is related to the distribution of the bene ts stemming from economic activity.

So Public Intervention is justify in case we have a Market Failure (whenever any assumption of the competition model is violated)

and, as a consequence, the economy does not reach an ef cient allocation.

WAGNER LAW

Bear in mind that a similar process affects most advanced economies, both European and non-European.

Wagner’s law tries to explain the increase in public expenditure on the basis of 3 mechanisms:

1. ECONOMIC GROWTH CREATE AN INCREASE IN THE SYSTEM’S COMPLEXITY.

(= when Economic or GDP grow it means that this increase the complexity of the system)

Societies have a growing need for laws and more complex regulations);

2. THE URBANISATION PROCESS CAUSES NEW COSTS (infrastructure, pollution);

(cities are hot spots! There are more complex objects to handle!)

3. ECONOMIC GROWTH PRODUCES AND INCREASE IN DEMAND for speci c goods that are typically produced

and distributed by the public sector (education, healthcare).

How to imply the money we earn/own?

Strong evidence: this type of decision (or portfolio of choices) change as the level of income also change.

ASSUMPTION OF PERFECT COMPETITION MODEL:

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1. EXCLUDABILITY : Goods cannot be consumed by more than an individual simultaneously

(if Adam eats an apple, the same apple can no longer be eaten by Eve)

2. PRICE SYSTEM AS A VEHICLE OF MARKET SIGNALS: The actions of an individual (or rm) have no direct effect

on other individuals, other than through the price system; (quantity availability and demanded)

3. PRICE-TAKING BEHAVIOUR: Consumers and rms act as price-takers (Individual consumer are price taker)

Crucial assumption both rms and individual cannot in uenced the price.

4. PERFECT INFORMATION: Consumers and rms have full information about the quality and availability of goods

on the market, as well as about relative prices.

When I do have a violation (fully or partially) of one or more of the 4 assumption for perfect completion model I would

have a Market Failure.* 4 di 16

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COMPETITION MODEL

MARKET FAILURES: ASSUMPTION 1 (PUBLIC GOODS)

1. EXCLUDABILITY: Goods cannot be consumed by more than an individual simultaneously (if Adam eats an apple,

the same apple can no longer be eaten by Eve);

PUBLIC GOODS are those goods that allow simultaneous consumption by more consumer.

Defence: all citizens of a given Country are simultaneously protected.

Radio waves: simultaneously received by anyone located within signal reach.

These are two examples of public goods: whenever more than one consumer bene ts from the consumption of a

unit of the same good, welfare theorems are violated.

Q:Which fundamental conditions characterise a public good? As a consequence, which characteristics does a private good display?

PERFECT PUBLIC GOODS SATISFIES 2 CONDITIONS:

1. NON EXCLUDABLE (or Non excludability).

If a public good is produced, no individual can be prevented from its consumption.

2. NON RIVALRY: the consumption of a public good from an individual does not exclude others from consuming

the same good.

When are rival good? Scarcity for example. (ex. water, beaches)

—> AS A CONSEQUENCE A PRIVATE GOOD IS BOTH RIVAL AND EXCLUDABLE IN CONSUMPTION.

Types of goods: they can be characterised by a different combination of rivalry and excludability in consumption:

Technically I cannot exclude anyone, but if too many people simultaneously consume the good, the quality of consump-

tion decrease.

In the case of a pure public good, the marginal cost (MC), i.e. the cost to provide it to an additional person,

is equal to zero and it is not possible to exclude any individual from its consumption.

NB: several goods provided by the public sector are actually impure public goods!

Example. The cost for an additional traveller on an empty road is very low, but it is not exactly equal to zero.

Besides, whenever the road is jammed, the marginal cost of an additional traveller increases dramatically. 5 di 16

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Why can the private sector not sell public goods?

Example:

We have a large ship-maker (A) and several smaller ship owners (from 1 to n; e.g., shermen), using the same harbour.

Everyone would need a lighthouse. A evaluates her costs and bene ts before deciding whether or not to build the

lighthouse. Let’s assume that CA > BA. Consequently, A will decide not to build the lighthouse.

However, this investment would be pro table if we took all bene ts into account:

CA< BA+ B1+ B2+ ...+Bn

Therefore, a single individual is not willing to pay for the public good, but what would happen if all ship-makers/users

would form a union and would jointly build the lighthouse sharing the bill?

SO:

Free riding problem: some ship-owners will refuse to pay (example: contribution campaign)

Free ride: you get the bene ts without paying the costs for this good.

ex White house: public good. Why no private sector? No individual will pay this public good by itself.

In general, we can conclude that:

Even if there could be some form of supply of public goods even in the absence of the public sector, in general

we need public intervention in order to supply public goods, because the government can force taxpayers to

contribute for them.

Example: Major Public Good: Health.

COMMON RESOURCES (Rival in consumption – Non-Excludable):

They encompass those goods that cannot be privately consumed and that, once consumed, are no longer available.

• While it is in the interest of everyone that these resources are not spoiled, everyone faces an incentive to over-exploit

them. Ex.: pastures, of ce copying machines.

CLUB GOODS (non rival in consumption - excludable)

A club good is non-rival in consumption, or only partially rival, but the supplier can exclude someone from its con-

sumption. The excludability issue can also be interpreted literally (ex. request of a membership card).

Ex.: pay-TV, gyms.

LOCAL PUBLIC GOODS: (Local: geographical bounded) (no-rival and no excludable)

Only residents of a particular area can bene t from a local public good. This good can be non-rival or partially rival

within that speci c geographical context. You can think of a local community much like a club.

Ex.: access to limited traf c areas within a city. 6 di 16

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COMPETITION MODEL

MARKET FAILURES: ASSUMPTION 2 (EXTERNALITIES)

2. PRICE SYSTEM AS A VEHICLE OF MARKET SIGNALS: The actions of an individual (or rm) have no direct effect

on other individuals, if not through the price system.

Q: De ne the concept of externality. On which elements do externalities exert their effect?

An externality of the price system is an interaction between economic agents (*) taking place outside the mar-

ket economy. There is an externality any time the utility or pro t (welfare) of some economic agents are directly

in uenced by the way other agents (consumers or producers) behave in the economy.

Externalities not in uence price but rather the quantities.

Externalities = External to the price system!

(Economic Agents*una persona, azienda o organizzazione che ha un'in uenza sull'economia producendo, acquistando o vendendo:

il corretto funzionamento dell'economia di mercato è in uenzato principalmente dall'interazione dello stato con l'agente

economico).

With “directly” we exclude any effect that is mediated by the price system.

THE TEST OF THE EFFICIENCY of the market is based on TWO ASSUMPTIONS:

1. The welfare of each consumer depends only on her consumption level (Adam is not interested in what

Eve is doing). Externality: I’m eating a sandwich while my neighbour is smoking;

2. The production of each rm depends only on its on decisions about production factors (inputs) to be

used and the quantity (output) to produce. Externality: production of shermen on a lake is in uenced by

how much pollution the re nery located upstream generates

EX. 1 - TRAFFIC JAMS

TRAIN: how much time to commute (fare il pendolare) by

train? Whatever traf c exists, trains are better, and travel

time remains the same.

CAR: Positive incentive, more people you have traveling

the more traf c you have, the more time you get to travel.

Individual consumers travel by car if beyond level of e.

e: equilibrium: is reached in e; however, o is more ef cient

than e.

Time travel by car increases with the number of cars tra-

• velling on the highway.

Equilibrium is reached in ‘e’; however, ‘o’ is more efficient than ‘e’.

•

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