econ 134

Major Factors that Would Shift the Entire Demand Curve:

1. Income 2. Price of related goods (complements, substitutes) 3. Consumer preferences 4. Consumers' expectations in future price 5. The number of consumers

What are the basic steps for doing a cost-benefit analysis?

1. List all costs and benefits 2. Nonmarket valuation is used to estimate values of nonmarket goods (such as human health and 3. If actual nonmarket values cannot be estimated, consider transferred values or expert opinions. 4. Add up all the costs and the benefits. 5. Compare total costs to total benefits to obtain a recommendation.

The basic steps of a CBA for a proposal project

1. List all costs and benefits 2. Nonmarket valuation is used to estimate values of nonmarket goods (such as human health and ecosystem impacts) 3. If actual nonmarket values cannot be estimated, consider transferred values or expert opinions. 4. Add up all the costs and the benefits. 5. Compare total costs to total benefits to obtain a recommendation.

two main ways of presenting the bottom-line result of a CBA

1. Net benefits: This is total benefits minus total costs. 2. Benefit/cost ratio: This is total benefits divided by total costs.

Major Factors that Would Shift the Entire Supply Curve

1. Price of input goods and services 2. Production Technology 3. Natural disruption 4. Number of firms in the market 5. Producers' expectations of price in future

What is the "correct" discount rate?

1. Set it equal to the rate of low-risk investment (government bonds). The market rate of return represents the opportunity cost of spending money now. 2. Two justifications a) Pure rate of time preference (The natural human tendency to prefer the present over the future.) b) Assuming that economic growth is continues, people in the future will be richer than people now.

Four concepts of Environmental Economics

1. The theory of environmental externalities 2. The optimal management of common property and public goods 3. The optimal management of natural resources over time 4. The economic valuation of environmental goods and services

Cost-Benefit Analysis (CBA)

A tool for policy analysis that attempts to monetize all the costs and benefits of a proposed action to determine the net benefit

marginal benefit (demand curve)

Additional benefit of consuming one more unit of good or service.

marginal cost curve (supply curve)

Additional cost of producing one more unit of a good and service.

Externalities

An effect of a market transaction that impacts the utility, positively or negatively, of those outside the transaction.

Tragedy of the common

Common property resources are overexploited while individual incentives promote expanded exploitation. Avoid problem with government using a license fee to discourage overuse of resource

limitations of cost-benefit analysis

Cost-benefit analysis of environmental policies are difficult and controversial because several of the most important benefits of environmental improvements are difficult to quantify: nonuse values can only be estimated by the stated preference methods (CV, Conjoint analysis), and the validity of this method is a subject of debate among economists discount rate---environmental policies often involve up-front costs and longer-term benefits. This makes the choice of a discount rate critically important. A lower discount rate tends to support greater environmental protection.

Discounting Rate

Costs and benefits that occur in the future should be assigned less weight (discounted) relative to current costs and benefits

expected value formula

EV(xi) = P(xi) * NB(xi) probability P(xi) multiplied by its net benefit (or cost) --The formula for expected value does not take into account risk aversion

Coase Theorem

If property rights were well defined, and there no transaction costs, an efficient allocation of resources will result even if there are externalities.

Constant returns to scale

Increasing the number of inputs leads to an equivalent increase in the output.

Common Property Resources

It is accessible to everyone and not subject to private ownership (non-excludable) . Use of resource may diminish the quality or quantity available to others (rival). Examples: Irrigation system, forests, fishery, and atmosphere

Will free markets tend to produce a sufficient supply of public goods?

No, government intervention and public funds are needed to achieve the social benefits that flow from providing these public goods

What are the two major characteristics of public goods

Nonexcludable: Goods are available to all. Nonrival: Its use by one person does not reduce its quality or availability to others. Ex: parks, national defense, public radio, street lights, fresh air

Present value of $X in nth year

PV(Xn) = X/(1+r)^n

Present Value Formula

PV(Xn) = Xn / (1 + r)^n Where n: the number of years in future, PV: present (or discounted) value of $X in nth year, r: discount rate (annual rate at which future values are reduced, expressed as a proportion)

examples of positive externalities

People who get vaccinations against communicable disease reduce other people's chances of getting the disease. A neighbor who hires a security guard may also (indirectly) provide protection for me. A farmer drains his land happens to also drain his nearby neighbor's land.

SrTP Formula

SRTP = ρ + (ε * c) where ρ is the pure rate of time preference, c is the growth rate of consumption, and ε is the elasticity of the marginal utility of consumption (%Δ U/%ΔC), (ε * c) tells us how much better off a society is as it gets richer

Producer Surplus

The difference between the current market price and the full cost of production for the firm. = The price that producer actually receives - Costs to produce an additional unit of output

Consumer Surplus

The difference between the maximum amount a person is willing to pay for a good and its current market price = What consumers are willing to pay - What they actually have to pay

What is the difference between willingness to pay and willingness to accept?

The economic value that people obtain from a specific resource is defined as their maximum willingness to pay (WTP) for it. We can also ask how much people would be willing to accept in compensation for these changes. This is the willingness to accept (WTA) approach to environmental valuation.

How can a license fee be used to improve economic efficiency? How can the price of the license fee be determined?

The license fee is difference between average revenue and average cost at the efficient outcome License fee is the fee paid for access to resource.

Examples of Negative Externalities

The pollution generated by a firm that imposes costs on people located near the firm. Underground water pumping by one farmer lowers the water table for other users that thus raises the cost of pumping water to these other users. Activity that results in increased CO2 emissions (greenhouse gas) that affects global climate.

Total product

The total quantity of a good or service produced with a given quantity of inputs.

How do we calculate total revenue, average revenue, and marginal revenue?

Total Revenue = Price * Quantity Average Revenue= TR/Q MR = ΔTR/ΔQ

Absolute diminishing returns

When inputs increases, marginal (additional) output is decreasing, and the total output also decreases. --overfishing

Diminishing returns

When inputs increases, marginal (additional) output is decreasing, but the total output increases.

What did the NOAA panel conclude about contingent valuation?

While the NOAA panel concluded that CV studies may produce valid estimates of nonuse values, it also provided a long list of recommendations in order for a CV survey to be considered acceptable

social discount rate/ social rate of time preference (SrTP)

a discount rate that attempts to reflect the appropriate social valuation of the future; the SRTP tends to be less than market or individual discount rates

subsidy

a payment to a producer to provide an incentive for it to produce more of a good or service

pigovian tax

a per-unit tax equal to to the external damage caused by an activity

cost-effectiveness analysis

a policy tool that determines the least-cost approach for achieving a given goal

defensive expenditures approach

a pollution valuation methodology based on the expenditures households take to avoid or mitigate their exposure to a pollutant. collects data on actual expenditures to obtain a lower-bound WTP for environmental quality changes

contingent ranking (CR)

a survey method in which respondents are asked to rank a list of alternatives

positional analysis

a. a policy analysis tool that combines economic valuation with other considerations such as equity, individual rights, and social priorities; it does not aim to reduce all impacts to monetary terms

sensitivity analysis

an analytical tool that studies how the outputs of a model change as the assumption of the model change; considers whether the recommendation changes when we change some of the assumptions of the analysis

cost of illness method

an approach for valuing the negative impacts of pollution by estimating the cost of treating illnesses caused by the pollutant.

replacement cost methods

an approach to measuring environmental damages that estimates the costs necessary to restore or replace the resource, such as applying fertilizer to restore soil fertility. --not measures of WTP or WTA can be used to estimate the indirect use value of ecosystem services. These approaches consider the costs of actions that provide human-made substitutes for lost ecosystem services

welfare analysis

an economic tool that analyzes the total costs and benefits of alternative policies to different groups, such as producers and consumers

contingent valuation (CV)

an economic tool that uses surveys to question people regarding their willingness to pay for a good or, such as the preservation of hiking opportunities or air quality --most common stated preference method

benefit transfer

assigning or estimating the value of a resource based on prior analysis of one or more similar resources

free-rider effect

barrier to successful negotiations, in which there is a tendency not to pay one's share of the costs but still attempt to receive the benefits

ecosystem services

beneficial services provided freely by nature such as flood protection, water purification, and soil formation

nonmarket benefits

benefits not obtained from goods and services sold in markets.

What are the three phases of a total product curve for a common property resource?

constant returns, diminishing returns, absolutely diminishing returns

If demand is inelastic, the majority of the tax incidence falls on

consumers

sustainable development

economic development that is conducted without depletion of natural resources

stated preference methods

economic valuation methods based on survey responses to hypothetical scenarios, including contingent valuation and contingent ranking

indirect-use values

ecosystem benefits that are not valued in markets, such as flood prevention and pollution absorption tangible benefits obtained from nature without any effort on our part

How do we determine the economic optimum level of production with a common property resource? How will this differ from the open access equilibrium?

efficient outcome occurs where MR=MC open-access equilibrium occurs where AR=AC

What are global commons?

global common property resources such as the atmosphere and the oceans. New (or reformed) institutions are needed to manage common property resources at the global level. (Difficulties) -Establishing effective international authority to regulate activities. -Free rider effects. - Human economic activities increases.

As demand elasticity increases, the deadweight loss

increases

revealed preference methods

indirectly infer the values that people place on environmental goods or services based on market decisions

Is a high or low discount rate inherently better for environmental protection?

low

Market failure

market fails to produce produce an outcome that is the most beneficial to society

real or inflation-adjusted dollars

monetary estimates that account for changes in price levels (i.e., inflation) over time

What do we mean by "optimal" pollution? Why shouldn't pollution levels be zero?

optimal level of pollution: the pollution level that maximizes net social benefits the only way to achieve zero pollution is to have zero production. If we want to produce virtually any manufactured good, some pollution will result. We as a society must decide what level of pollution we are willing to accept

What are the three types of non-use values?

option value: the value that people place on the maintenance of future options for resource use. bequest value: the value that people place on the knowledge that a resource will be available for future generations. existence value: the value people place on a resource that they do not intend to ever use, such as the bene t that one obtains from knowing an area of rain forest is preserved even though he or she will never visit it

If demand is elastic, the majority of the tax incidence falls on

producers

Risk

term used to describe a situation in which all potential outcomes and their probabilities are known --Risk can be quantitatively incorporated into a CBA, while uncertainty cannot.

Uncertainty

term used to describe a situation in which some of the outcomes of an action are unknown or cannot be assigned probabilities

discount rate

the annual rate at which future benefits or costs are discounted relative to current benefits or costs

risk aversion

the common tendency to avoid risky situations, particularly those that involve losses

Discounting

the concept that costs and benefits that occur in the future should be assigned less weight (discounted) relative to current costs and benefits

present value

the current value of a steam of future costs or benefits; a discount rate is used to convert future costs or benefits to present values.

open-access equilibrium

the level of use of an open-access resource that results from a market with free entry; this level of use may lead to depletion of the resource. the point at which there is no further incentive for entry to or exit from the market. Profit=0 Occurs where AR = AC

Total Benefits (also called Total Value or Total Willingness‐to‐Pay)

the maximum amount someone is willing to pay for a certain number of units of a good.

Marginal Benefits (also called Marginal Value or Marginal Willingness‐to‐Pay)

the maximum amount someone is willing to pay for one more unit. MB is change in TB divided by change in Q.

pure rate of time preference

the rate of preference for obtaining benefits now as opposed to the future, independent of income level changes.

total economic value

the sum of the different use and nonuse values

travel cost method (TCM)

the use of statistical analysis to determine people's willingness to pay to visit a natural resource such as a national park or river; a demand curve for the resource is obtained by analyzing the relationship between visitation choices and travel costs.

hedonic pricing

the use of statistical analysis to explain the price of a good or service as a function of several components, such as explaining the price of a home as a function of the number of rooms, the caliber of local schools, and the surrounding air quality

direct-use value

the value one obtains by directly using a natural resource, such as visiting a national park.

use values

the value that people place on the use of a good or service. tangible benefits that can be physically observed

expected value

the weighted average of potential values; Expected value takes into account the probabilities of different possible outcomes

Individual transferable quotas (ITQs)

tradeable rights to harvest a resource, such as a permit to harvest a particular quantity of fish

What are the three revealed preference methods?

travel cost method, hedonic pricing, and defensive expenditures approach

What do we mean by "internalizing externalities"

using approaches such as taxation to incorporate external costs into market decisions

nonuse values

values that people obtain without actually using a resource; nonuse values include existence and bequest values derived from the intangible well-being benefits that we obtain from the environment

Positive externalities

( also called external benefits) occurs if an activity confers benefits on those not involved in the activities.

Negative externalities

(also called external cost) occurs if an activity creates cots (harm or discomforts) for those not involved in the activity. (ex. Pollution)

Limitations of Coase Theorem

--How about if property rights were not clearly assigned? (example: water rights) --Free-rider effect --There are only two agents in the Coase Thorem --The theorem assumes that there are no transaction costs. --Equity and Distribution Issues --Issues of environmental impacts on nonhuman life forms and ecological systems.