Download Welcome to ECON 325 - University of Puget Sound

Week 1:
Intro. (anyone remember markets?)
&
valuation issues
the economy
Firms
(production)
Inputs
THE ECONOMY
Households
(consumption)
Outputs
the environment as an asset (environomy)
NATURE
Wastes
Firms
Impacts on
biodiversity
(production)
Inputs
Resource inputs
THE ECONOMY
Households
(consumption)
Global life-support
Outputs
Amenity values
criteria for decision making

is a proposed plan desirable?

benefit cost analysis can help

if B > C, support

if B < C, oppose

but how to measure the B and C?
anthropocentric focus



system of measurement is humancentered
all B and C valued in terms of their effects
on humanity
controversial, but a good starting point.
what is the alternative?
 but
before we start measuring
benefits and costs…
a
review of markets…
demand

relationship between the quantity
demanded and the price of a good when
all other influences (tastes and
preferences, prices of substitutes and
complements, income, numbers of
consumers and consumer expectations)
on buying plans remain the same
demand


law of demand – ceteris parabis (With all
other factors remaining the same) –
if p ↑, QD ↓
if p ↓, QD ↑
demand curve downward sloping
$
demand
Quantity
demand = MB


demand curve for pizza tells us dollar’s
worth of other goods give up to get 1
more pizza
consumer surplus: MB – price paid
consumer surplus
benefits derived from demand

demand measures amount particular good people
willing to purchase at different prices
demand and willingness to pay



total WTP (total benefits) is sum of WTP for each unit
sum is the total area under demand curve
what are total benefits in this case?
supply

The relationship between the quantity
supplied and the price of a good when all
other influences on selling plans
(production costs such as labor, energy,
capital, and materials) remain the same
supply


law of supply – ceteris parabis –
if p ↑, QS ↑
if p ↓, QS ↓
supply curve upward sloping
$
supply
Quantity
supply = MC


supply curve for pizza tells us dollar’s
worth of other goods give up to produce 1
more pizza.
producer surplus: Price – MC
producer surplus
marginal cost and total cost




all env. goods / services have costs (opportunity costs)
marginal cost: cost of producing last unit
total costs sum of marginal costs; area under mc curve
what is total cost in this case?
how much to preserve?
environmental economic to the rescue
3
step analysis
– identify optimal allocation
– does it exist?
– how to implement it (policy)
 examples
– natural resources: fishery
– environmental econ: solid waste /
landfill
optimal allocation: MB = MC



At q*, MB = MC, net benefits maximized. Cannot
increase benefits by changing q
MB = MC → Efficiency – cannot make one person
better off without hurting another
Why?
$
MB = MC
S = MC
D = MB
Quantity
MB > MC
q*
MC > MB
MB = MC



If MB > MC, can increase quantity → increases
benefits more than increases costs
→ total net benefits increase
If MC > MB, can decrease quantity → decreases
cost by more than decreases benefits → total net
benefits increase
Only at q* impossible to increase net benefits by
changing quantity
maximize net benefit!


net benefit: excess of benefits over costs
area under demand curve / above supply curve
static efficiency



net benefit from using the resource is
maximized
back to fig 2.5
is action that preserves 4 miles of river
worth doing? (not if preserving 5 is better)
what is efficient level of preservation?

what is we preserve 5 instead of 4?

net benefit increases by area MNR

therefore 4 miles of preservation is not efficient

are 5?


if preserve 6, C > B (triangle RTU is reduction of
net benefit)
cannot be better off preserving more or less than
5
dynamic efficiency


above was static analysis (one time
period)
maximizes present value of net benefits
that could be received from all of the
possible ways of allocating those
resources over the n periods
discounting



most environmental/nat resource issues
depend on time
present value: allows comparison of net
benefit received in one time period to
another
discount rate is the rate at which society
as a whole is willing to trade off present
for future benefits
why are discount rates needed?

a dollar received today is considered more valuable than one
received in the future

4 primary reasons for applying a discount rate:
1.
positive rates of inflation diminish the purchasing power of
dollars over time
2.
dollars can be invested today, earning a positive rate of return.
discount rates reflect the opportunity cost of capital (expected
financial return forgone by investing in a project rather than in
comparable financial securities)
3.
uncertainty surrounding the ability to obtain promised future
income. That is, there is the risk that a future benefit (e.g.,
enhanced fish catches) will never be realized
4.
humans are generally impatient and prefer instant gratification to
waiting for long-term benefits
pv
one time benefit (in yr. 200)
PV [ B n]  B n n
(1  r )
n
PV [ B0 ,..., Bn]   Bi i
i 0 (1  r )
B
PV
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
r
$820,348.299875
$371,527.882127
$138,032.967198
$19,053.100033
$50.108813
$0.002511
$0.000000
total benefit over all 200 years
n
0.02
0.02
0.02
0.02
0.02
0.02
0.02
B
10
50
100
200
500
1000
2000
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
$1,000,000.00
PV
r
$744,093.914897
$228,107.079790
$52,032.839850
$2,707.416423
$0.381406
$0.000000
$0.000000
n
0.03
0.03
0.03
0.03
0.03
0.03
0.03
10
50
100
200
500
1000
2000
how to choose a discount rate?




at one extreme, an infinitely high discount rate
would render all future actions meaningless
other extreme, using no discount rate means that
benefits today are no more valuable than benefits
experienced 100 years from now
neither of these extreme views is correct
real question is, “what discount rate best reflects
the time preference, productivity, and risk of this
project?"
common proxies

federal opportunity cost of capital
– the absence of the project, the federal
government could put the funds to productive
use reducing the national debt
– Federal bonds, ~3-6% average

the rate of productivity growth
– ~3%
NOAA has adopted a 3% discount rate
 OMB uses 7% (ror in private sector)

example:
should govt establish a
national marine sanctuary?



assume that a marine ecosystem is threatened
by polluted runoff from development; waste from
sewage, detergents, and fertilizers; destructive
fishing methods; and offshore oil drilling
threatens the viability of reefs and seagrass beds,
and threatens the long-term sustainability of the
fish and other seafood harvests
in response, the federal government is
considering establishing a NMS to provide
comprehensive protection of the marine
environment
list the benefits

Direct economic benefits:
–
–
–
–

more ecotourism
enhanced seafood harvests
better bird watching
a fishing catch that is sustainable in the longterm
Indirect economic benefits
– preservation of cultural and historic sites (e.g.,
lighthouses and ship wrecks)
list the costs


productivity losses incurred by industry as
a result of the prohibition on off-shore
drilling, waste dumping, and net fishing
private industry could be required to
purchase costly equipment to comply with
new regulations related to the treatment
of industrial waste products (abatement
cost)
max net benefit, not b-c ratio
Costs
Net Benefits
Benefit-Cost
Ratio
A
1,200.0 1,100.0
100.0
1.091
B
1,350.0 1,200.0
150.0
1.125
C
1,475.0 1,300.0
175.0
1.135
D
1,580.0 1,400.0
180.0
1.129
E
1,682.0 1,500.0
182.0
1.121
F
1,778.0 1,600.0
178.0
1.111
Plan
Benefits
simple benefit-cost excel example
r
t
0
1
2
3
4
5
6
7
8
9
0.07
benefits
0
0
0
0
3
3
3
3
3
3
PV benefits
0
0
0
0
2.288685636
2.138958538
1.999026671
1.868249226
1.746027314
1.631801228
costs
PV costs
5
5
5 4.672897
5 4.367194
0
0
0
0
0
0
0
0
0
0
0
0
0
0
11.67274861
14.04009
bc ratio
0.03
0.07
1.02
0.83
0.831387