Thursday, 11 December 2008

Environmental damage as analogous to aggregate demand externalities

I am looking at whether environmental damage can be modelled macroeconomically in the same way as aggregate demand externalities. A quick search did not show anyone having modelled environmental damage in exactly the way I am thinking, but probably someone has done something similar.

Aggregate demand externalities arise when people's and companies' individual actions alter the total demand for all goods in the economy. These actions may be modelled assuming that the people and companies are not individually affected by their decisions as much as the whole economy. The collective effect of all actions on everyone in the economy can be large, however.

The way a macromodel including environmental damage could be set up seems clear enough. People assume their individual actions do not have much effect, but collectively they do. So there is scope for governmental action, depending on the model parameters.

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