Is it inappropriate for an author to copy and paste from his/her original paper in an extension paper? I am currently a referee for a paper.
One of the authors of the paper had written an earlier paper,
which I will refer to as the "original paper,"
and the paper which I am now refereeing is an extension of the original paper,
which I will refer to as the "extension paper."

I have found that large portions of the extension paper
are copied from his original paper.
In particular,
a whole section of definitions is copied from his original paper;
and some paragraphs in the introduction and literature review
are copied wholesale or with slight modifications from the original paper.

Is it acceptable for an academic paper to copy paragraphs and even a section from an earlier paper by the same author?

My intuition suggests that it is acceptable to copy the definition section,
with an acknowledgement that it came from the original paper,
since definitions are standard.
But it seems strange to me for the introduction and literature review
to be too similar to the original paper.
The answer depends on the relationship between the papers, and I'm not sure which applies based on the information in your question.  In computer science, at least, there are two general cases:


The extension paper is the "extended journal version" of a previously published short-form work such as a conference paper, workshop paper, or extended abstract.  In this case, the rule of thumb is typically at least 30% new material.  The extended paper will often contain large chunks verbatim, as it is expected to supersede the original paper, rather than existing as a separate work.  
The extension paper is a separate work: in this case, extensive reuse of material is self-plagiarism.  Two exceptions: first, related work, methods, and definitional material may often be reused as long as it is appropriate to do so---the material should be appropriately customized to fit the new environment.  If the author would just be paraphrasing for the sake of paraphrasing, though, it's not necessary.  Second, introductory material may be partially shared, though it should be more heavily customized for the new context.


In all cases except for minor reuse of related work material, the extension paper must declare a clear and explicit relationship with the prior paper.

Note that many other fields do not have the notion of a "journal version" and thus have much stricter standards.