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Upcoming in Class. Homework #1 Due Thursday Group Quiz Next Thursday Writing Assignment Due Oct. 27th. Max. Net Benefit. Price of Good. Marginal Cost. Equilibrium Price. Marginal Benefit. Quantity of Good. Equilibrium Quantity. Static Model Time does not matter

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Upcoming in class
Upcoming in Class

Homework #1 Due Thursday

Group Quiz Next Thursday

Writing Assignment Due Oct. 27th


Max net benefit
Max. Net Benefit

Price of Good

Marginal Cost

Equilibrium Price

Marginal Benefit

Quantity of Good

Equilibrium Quantity


  • 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


Well defined property rights
Well-Defined Property Rights

  • 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

  • Transferability –

    • 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)


Market equilibrium
Market Equilibrium

Price of Good

Supply

Equilibrium Price

Demand

Quantity of Good

Equilibrium Quantity


Consumer surplus
Consumer Surplus

Price of Good

Supply

Equilibrium Price

Demand

Quantity of Good

Equilibrium Quantity


Producer surplus
Producer Surplus

Price of Good

Supply

Equilibrium Price

Demand

Quantity of Good

Equilibrium Quantity


Total welfare
Total Welfare

Price of Good

Supply

Equilibrium Price

Demand

Quantity of Good

Equilibrium Quantity


A note on rights
A Note on Rights

  • Efficient Property Rights => Net Benefits are Maximized

    • Consumer Surplus – area under the demand curve minus the area representing cost

    • Producer Surplus – area under the price line that lies over the marginal cost curve

    • Net Benefits = CS + PS


Externalities as a source of market failure
Externalities as a Source of Market Failure

  • Exclusivity – when the owner bears all of the consequences of his actions

  • Externality – when the welfare of some agent (individual, household, or firm) depends on the activities under control of some other agent.

    • Negative externalities (external diseconomy)

    • Positive externalities (external economy)


Market for electricity
Market for Electricity

Price of Good

Supply

Equilibrium Price

Demand

Quantity of Good

Equilibrium Quantity


Market for electricity with externalities
Market for Electricity with Externalities

Price of Good

Marginal Social Cost

Marginal Private Cost

P*

Market

Price

Demand

Quantity of Good

Q*

Market

Quantity


How would you graph a positive externality
How would you graph a positive externality?

Example, when Duncan Hines produces brownie mix, it pollutes a small amount of cocoa powder into the air. This makes the air smell like brownies, and increase the MSB from the production of brownies.


Coase theorem
Coase Theorem

  • If property rights are well-defined, and no significant transaction costs exist, an efficient allocation of resources will result even with externalities.


Dealing with externalities
Dealing with Externalities

  • The Pursuit of Efficiency

    • Legislative and Executive Regulation

      • Direct Control – Quota

      • Cap and Trade

      • Pigovian Tax – “polluter pays principle”

        • Not always clear who pays


Pigovian Tax Problem

  • Suppose the demand function for gasoline is

  • Pd = 6.5 - 0.5 Q where Q represents billions of gallons of gasoline.

  • Suppose the supply function for gasoline is based on the firms’ marginal private costs and equals

  • Ps=Q

  • What is the market equilibrium level of output and price?


Pigovian Tax Problem

  • Suppose the government’s EPA determines the socially optimal amount of gasoline use is actually 3 billion gallons of gasoline.

  • To reach this socially optimal quantity, the government is going to implement a per unit tax on the consumption of gasoline. The tax revenue from which will go to protecting the environment as determined by the EPA.

  • What should the tax amount be?

  • What price will the consumers pay?

  • What price will the sellers receive?

  • How much money will go to protecting the environment?


Market for electricity with externalities1
Market for Electricity with Externalities

Price of Good

Marginal Social Cost

Marginal Private Cost

P*

Market

Price

Demand

Quantity of Good

Q*

Market

Quantity


Defining goods
Defining Goods

Private Goods – rivalrous, excludable

Public Goods – non-rivalrous, non-excludable


Bio diversity as a public good
Bio-Diversity as a Public Good

  • Genetic Diversity

    • critical to species survival

    • Useful for cross-breeding to develop superior strains

  • Number of Species

    • Species interdependence

    • Provides new sources of food, energy industrial chemicals, raw materials, and medicines


Demand for a public good
Demand for a Public Good

  • Graphically

    • non-rivalry means that

      • if each of several individuals has a demand curve for a public good,

      • then the individual demand curves are summed vertically to get the aggregate demand curve for the public good.


Non rivalrous good problem
Non-rivalrous Good Problem

  • The Illinois Power Authority is considering updating its transmission substations to use “smart-grid” technology, which improves reliability and efficiency in the electric grid. Each time a new smart-grid meter is installed Chicago, Naperville, and Rockford customers all benefit from increased reliability of their electricity. A study was done to determine the benefit to each city as follows:

    • Chicago – Marginal Benefit=10-0.5Q

    • Naperville – Marginal Benefit=5-0.5Q

    • Rockford – Marginal Benefit=10-1Q

  • What is the total marginal benefit when five smart-grid meters are installed?


Example of public good
Example of Public Good

  • There are two people in the world

  • They both benefit from preserving the rainforest, with an inverse demand function

    • P=50-2Q

  • Preservation is a public good

  • The marginal cost of preserving the rain forest is $20 per acre.

  • Estimate total demand, and the optimal number of acres to preserve.


Coase Theorem Problem

  • A chemical factory is situated next to a farm. Airborne emissions from the chemical factory damage crops on the farm. The marginal benefits of emissions to the factory and the marginal costs of damage to the farmer are as follows

  • MB= 360 – 0.4 Q and MC=90+0.2Q

  • From an economic viewpoint, what is the best solution to this environmental conflict of interest?

  • How might this solution be achieved?


Upcoming in class1
Upcoming in Class

Homework #1 Due Thursday

Group Quiz Next Thursday

Writing Assignment Due Oct. 27th


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