How Do Different Firms Adapt to Climate Change Place Based Risks?
Lessons from a Pizzeria versus a Video Game Designer
When I was young, I would walk 1 mile to go to the local pizzeria in Hartsdale, New York. In my Urban Economics class, I teach my students why such pizza makers locate close to their customers. You can read my free textbook where I discuss the fact that pizza depreciates as a function of time so it must quickly get from the oven to the consumer. When the pizza maker locates closer to the consumer, the product’s quality is higher.
So What?
Pizza makers have relatively few adaptation adjustment margins. If enough pizza eaters live in Scarsdale, then it is profitable for a pizza maker to locate close by. This chain of events exposes the pizza maker to Westchester County, NY’s weather conditions.
Suppose that due to climate change that Westchester, County experiences 4 more days of flooding in the area and 50 more days of extreme heat. How does this “climate change” affect the pizza maker’s profits?
If this firm fails to adapt, then it will be closed for the 4 days that the area floods and the store may be damaged by the flooding. On the extremely hot days, it can expect that nobody will want to eat a heavy pizza.
The firm will pay less in rent because the aggregate demand for commercial space will decline. Depending on aggregate demand elasticity for pizza, the Westchester price of pizza will rise due to the supply side shock to pizza production. Why? All pizzerias will be less productive in the region.
In writing these paragraphs, I haven’t bothered to introduce a technological magic bullet such as a flying drone that can deliver a hot pizza in the midst of heavy rain. Such medium term adaptation could certainly happen. To simplify this discussion, I am focused on the short run given our current “menu” of adaptation strategies.
SO, my point is that the pizza place has relatively few adaptation margins but in general equilibrium it shares the cost of the climate shock with the property owners and the pizza eaters. Economic incidence ideas are rarely discussed in climate economics papers!
If pizza workers sign daily contracts, then the workers also bear part of the costs as they will only be employed on days when pizza will be made. If the pizza firm must sign a yearly contract of a fixed pizza maker salary then the pizza firm bears the incidence of weather shocks. For example, if there is no flooding one year then the pizza maker earns more profit.
Note that contract design plays a key role here in figuring out the profits earned by the pizza place in the face of extreme weather. If it can shut down when its operating profit is negative then this helps it to adapt BUT the workers who are idle that day bear the cost. How much they lose depends on their value of time. Suppose these workers who stay at home because there is no pizza demand that day can work on their “side gig” of designing their video game. In this case, they lose relatively little because they have a passion for design and are learning a skill (programming) that helps them.
Video game design can take place anywhere. Extreme weather doesn’t disrupt such programming as long as you have access to electricity. See our 2023 paper. So note what I did here, I provided a microfoundation for one’s value of time.
If workers in Westchester County, NY expect more extreme weather that disrupts their paid work, they will develop side gigs that they can work on at home! This is adaptation!!
Empirical economists ignore all of this heterogeneity because it is hard to observe but it does exist!
In my next column, I will return to the locational choice of a Video Game design firm and its options for how it adapts to extreme local weather.
There are many adaptation pessimists out there. They need to take a refresher course in microeconomics! My adaptation optimism is based on my thinking about microeconomics. We have strong incentives to protect ourselves from anticipated emerging threats. We are not “passive victims”. Markets help us to protect ourselves.
My 2010 Climatopolis book explores this theme in discussing how cities compete against each other to attract productive people and firms.
My 2021 Adapting to Climate Change book expands upon this theme. You can find these books on my Amazon page.