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Week 1: Intro. (anyone remember markets?) & valuation issues. the economy. Firms (production). Inputs. Outputs. THE ECONOMY. Households (consumption). the environment as an asset (environomy). NATURE. Impacts on biodiversity. Firms (production). Wastes. Inputs. Outputs.

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the economy
the economy

Firms

(production)

Inputs

Outputs

THE ECONOMY

Households

(consumption)

the environment as an asset environomy
the environment as an asset (environomy)

NATURE

Impacts on biodiversity

Firms

(production)

Wastes

Inputs

Outputs

THE ECONOMY

Households

(consumption)

Resource inputs

Amenity values

Global life-support

criteria for decision making
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
anthropocentric focus
  • system of measurement is human-centered
  • all B and C valued in terms of their effects on humanity
  • controversial, but a good starting point. what is the alternative?
demand
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
demand1
demand
  • law of demand – ceteris parabis (With all other factors remaining the same) –

if p ↑, QD ↓

if p ↓, QD ↑

  • demand curve downward sloping
demand2
demand

$

Quantity

demand mb
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
benefits derived from demand
benefits derived from demand
  • demand measures amount particular good people willing to purchase at different prices
demand and willingness to pay
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
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
supply1
supply
  • law of supply – ceteris parabis –

if p ↑, QS ↑

if p ↓, QS ↓

  • supply curve upward sloping
supply2
supply

$

Quantity

supply mc
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
marginal cost and total cost
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
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
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
MB = MC

$

S = MC

D = MB

Quantity

q*

MB > MC

MC > MB

mb mc1
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
maximize net benefit!
  • net benefit: excess of benefits over costs
  • area under demand curve / above supply curve
static efficiency
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 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
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
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
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:
  • positive rates of inflation diminish the purchasing power of dollars over time
  • 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)
  • 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
  • humans are generally impatient and prefer instant gratification to waiting for long-term benefits
slide30
pv

one time benefit (in yr. 200)

total benefit over all 200 years

how to choose a discount rate
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
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
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
list the benefits
  • Direct economic benefits:
    • more ecotourism
    • enhanced seafood harvests
    • better bird watching
    • a fishing catch that is sustainable in the long-term
  • Indirect economic benefits
    • preservation of cultural and historic sites (e.g., lighthouses and ship wrecks)
list the costs
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)