Download Lecture 2 - Illinois State University

 What’s
 What
the difference?
are some examples?
• The Self-Extinction Premise
 A society can germinate the seeds to it’s own
destruction.
 Malthusian view – Pop. Growth can’t keep up with our
use of…
 Oil, fish, forests, fresh water, clean air
• Examples
 Easter Island – Reliance and overuse of trees led to downfall
 Mayan civilization – Pop. Growth > Food Supply
 Resources
are scarce, but we will find
substitutes or innovation will lead to
more efficient use of the resource –
“necessity is the mother of invention
1.
2.
3.
History shows that when faced with
scarcity, societies always correctly
adapt to solve the problem.
History gives no clues as to whether
societies correctly adapt to solve
problems of scarcity.
History shows that when faced with
scarcity, societies never adapt to solve
the problem.

Natural Resource – resources that occur in a natural
state and are valuable for economic activity
• Exhaustible, Non-renewable resources
 Resources that are fixed in amount of the resource which may be
used up over time.
 Examples include fossil fuels, minerals such as iron, silver, and gold.
• Renewable resources
 Resources that can be regenerated over time.
 Examples,
 Depletable – A renewable resource that can be exploited and
depleted, such as soil and clean air.
1.
2.
Exhaustable
Depletable
50%
1
50%
2
1.
2.
Exhaustable
Depletable
50%
1
50%
2
1.
2.
Exhaustable
Depletable
50%
1
50%
2
1.
2.
Exhaustable
Depletable
50%
1
50%
2
 How
much rainforest do we really need?
• I want to maximize wealth and societal welfare.
 In
order to figure that out, I need to know
how many trees I should grow AND I
need to know how much paper people
use.

Marginal Analysis –
• Tool used to answer questions of ‘how much?’, by
examining very small changes.
• Benefits > Cost => Do more
• Benefits < Cost => Do less
• Examples,

Valuing the Resources
• Economic value of the a tree
• Anthropocentric view
 Direct value of tree’s existence- can make a chair out of it
 Indirect value – reducing carbon dioxide in air, protecting the
environment from global warming, pretty and other like it
 Willingness
to pay – max amount that we
would spend on a good.
 Marginal
Analysis –
• Tool used to answer questions of ‘how much?’, by
examining very small changes.
• Benefits > Cost => Do more
• Benefits < Cost => Do less
WTP for
Paper
stacks
p1
p2
q1
q2
Quantity of
paper stacks.
WTP for
Paper
stacks
p1
p2
q1
q2
Quantity of
paper stacks

The benefit lost when specific
environmental services are forgone in
the conversion to the new use
Price of
Paper
Stacks
p2
p1
q1
q2
Quantity of
Paper Stacks
Price of
Paper
Stacks
p2
p1
q1
q2
Quantity of
Paper Stacks
Price of
Paper
Stacks
p1
p2
q1
q2
Quantity of
Paper Stacks
Price of
Paper
Stacks
p1
p2
q1
q2
Quantity of
Paper Stacks
Price of
Paper
Stacks
Marginal
Cost
Equilibrium
Price
Equilibrium
Quantity
Marginal
Benefit
Quantity of
Paper Stacks
 First
Equimarginal Principle –
• Net benefits are maximized when the marginal
benefits from an allocation equal the marginal
costs
• Efficient
• Max. Net Benefits

One convenient way to express WTP between price
and quantity is through the inverse demand function.
In an inverse demand function, the price consumers
are willing to pay is expressed as a function of the
quantity available for sale. Suppose the inverse
demand function of a product is
• P=80-q

And the marginal cost of producing the product is
• MC=1q
• A) How much would be supplied in a static efficient allocation?
• B) What would be the magnitude of the net benefits?
• Static Model
 Time does not matter
 Cost/Benefit Analysis – cutting down trees
 Benefit > Cost => support action
 Cost > Benefit => oppose action
• Dynamic Model
 Account for time
 Cost/Benefit Analysis accounting for time
 Max [B0, B1, B2]
 Present Value – $1 invested today at 10% interested yields
$1.10 a year from now.
 Present Value (PV) of X one year from now is X/(1+r)2
 r is the interest rate (discount rate)
 PV[Bn]=Bn/(1+r)n
 PV[B0, B1, B2]= B0/(1+r)4 + B1/(1+r)3 +B2/(1+r)2
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
 Exclusivity –
• All benefits and costs accrued as a result of owning
and using the resources should accrue to the owner,
and only the owner, either directly or indirectly by
sale to others
 Transferbility –
• All property rights should be transferable from one
owner to another in a voluntary exchange
 Enforceability –
• Property rights should be secure from involuntary
seizure or encroachment by others (ie. eminent
domain)
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
 Be
able to explain what a negative
externality is, and give an example.