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  1. Upcoming in Class • Homework #8 due • Group Outline due • Next Thursday • Homework 9 • Quiz 4

  2. Homework 8 • Suppose a proposal is made to construct a new interstate highway through a plot of undisturbed land. Briefly summarize how you would use cost-benefit analysis to evaluate this proposal. What economic techniques would you use to assess some of the environmental impacts?

  3. Homework 8 • What is the difference between willingness-to-pay and willingness-to-accept? Do the two measures tend to be similar when used to value the same good or service? Why is this a problem with economic valuation?

  4. Chapter 6 – Discount Rate Accounts for the time value of money Rate at which a dollar value increases over time Present Value – The value of money in the future, put in terms of the value of money today.

  5. Discounting For the ith period PV [Bi] = Bi/(1+r)i For the sum across all period PV [B] = ∑i=1n Bi/(1+r)i

  6. Present Value of$1,000 at Different Discount Rates

  7. Discounting & Environmental Policies The discount rate affects policies that have long term consequences. For example, consider the construction of a dam. 3 years to build 50 years of operation 50+ years of environmental damage

  8. Costs and Benefits of a Dam Project

  9. Discount Rate • If r is set high • The short run is favored. • Poor societies where struggle for today is impossible • Developed countries where the term of office for policymakers is short • Benefits of dam will be stated as smaller • But so will the cost environmental damage

  10. Discount Rate • If r is set low • Weights long term environmental damage heavier. • If the damages extend beyond the life of the project, then it is likely that the project will be canceled.

  11. Discount Rate and Policy • Neither a high or low discount rate is better for environmental valuation. • Low discount rates are often advocated on the needs of future interests • Global Climate Change • Soil Erosion

  12. Discount Rates Utilized OMB = rate of return on government bonds (1.6 to 3.5) World Bank often uses 10 Sensitivity Analysis is an analytical tool that studies how the outputs of a model changes as the assumptions of the model changes.

  13. Future Outcomes Risk – the probability that an event will happen Uncertainty – different outcomes may occur Consider a person who smokes

  14. Expected Values EV [X] = p[X] C[X] p is the probability of event X occurring C is the cost of event X

  15. Expected Values • Risk aversion is the tendency to prefer certainty instead of risky outcomes, particularly in cases where actions may cause significant negative consequences • Precautionary principle is the view that policies should account for the uncertainty by taking steps to avoid damaging outcomes, especially when the outcomes are irreversible

  16. Chapter 12 – Non-renewable Resources Physical supply - available reserves measured in physical terms without regard for cost and value Economics supply – the amount of a resource that is available based on current prices and technology

  17. Classification of Nonrenewable Resource

  18. Reserves Identified reserves – the identified quantity of a resources; includes both economic and subeconomic reserves Indicated or inferred – resources that have been identified but whose exact quantity is not known with certainty

  19. Undiscovered Reserves Hypothetical – the quantity of a resource not identified with certainty but hypothesized to exist Speculative – the location and quantity of a resource has not been identified but is hypothesized to exist

  20. Resource lifetime Subeconomic resources – resources whose costs of extraction are too high to make production worthwhile Economic reserves – resources of high enough quality to be profitably produced and are identified

  21. Resources • Changes to reserves • The resources is extracted and used => diminished reserves • New resource deposits are discovered => increasing reserves • Changing price and technology can make more or less of the known reserves economically viable

  22. “Limits to Growth” • http://en.wikipedia.org/wiki/The_Limits_to_Growth • Written in 1972, predicting over use of resources • http://en.wikipedia.org/wiki/The_Population_Bomb • Written in 1968, predicting a population crash due to resource scarcity • The wager : http://en.wikipedia.org/wiki/Simon%E2%80%93Ehrlich_wager

  23. Price Trends for Selected Minerals

  24. Optimal extraction R=P-MC PV [R] = R0 + R1/(1+r) + R2/(1+r)2 +… Optimal extraction quantity R0= R1/(1+r) = R2/(1+r)2=… Hotelling’s Rule - net price rises over time with the rate of interest.

  25. Resource Rent for the Competitive Firm

  26. Marginal Cost of Extraction Technology Decreases marginal cost of extraction Higher quality resources will be extracted first. => subeconomic resources may become economic when the price rises or technology improves

  27. Exhaustion of a Mineral Stock

  28. Resource Extraction Choke price – the minimum price of a good or service that would result in a zero quantity demanded Price path – the price of a resource over time Extraction path – the extraction rate of a resource over time

  29. Change in World ReserveBase for Selected Minerals

  30. Upcoming in Class • Homework #8 due • Group Outline due • Next Thursday • Homework 9 • Quiz 4