Upcoming in Class Homework #1 Due Thursday Group Quiz Next Thursday Writing Assignment Due Oct. 28th

Homework 1 1. What is the difference between a common good, a public good, and an open-access resource? Give examples of each.

Homework 1 2. Suppose the state of Illinois is trying to decide how many miles of the Vermillion River should be preserved in its natural state. It has been determined that 100 people will be affected by this decision and that the benefits derived by each individual are unaffected by the total number of people affected by the project. Each individual has the same inverse demand function for river preservation, which can be written as P = 10 - 1Q, where Q is the number of miles of the river that are preserved. The marginal cost of each mile of river preservation is constant and equal to $300.   a) Write the inverse supply function for river preservation.  b) Use the number of affected people, the inverse demand function, and the inverse supply function to determine the efficient amount of river preservation (in miles).  c) Calculate the net benefits from river preservation.  d) Develop a list of the possible benefits and costs of river preservation.

Homework 1 3. What is willingness to pay (WTP)? What is your WTP for a dozen eggs from Meijer? What is your WTP for a dozen farm fresh eggs from organically raised free-range chickens? Explain why they are different (or the same).

Homework 1 4. Assume a change in the quality of a good results in an increase in consumers’ willingness to pay. Assume also that the supply of the good is unchanged. Illustrate this situation graphically and identify the change in net benefits attributable to the change in quality.

Bio-Diversity Genetic Diversity Number of Species 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 Botany of Desire by Michael Pollan http://www.pbs.org/thebotanyofdesire/ Irish Potato Famine http://www.digitalhistory.uh.edu/historyonline/irish_potato_famine.cfm

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? Chicago = 7.5 Naperville = 2.5 Rockford = 5. Total benefit = 15

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.

Well-Defined Property Rights and Public Goods 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 – Enforceability – CO2 Cap and Trade: http://www.americanprogress.org/issues/2008/01/capandtrade101.html

Coase Theorem If property rights are well-defined, and no significant transaction costs exist, an efficient allocation of resources will result even with externalities. The theorem states that when trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.

Coase Example .Two pieces of land that are adjacent. Farmer McDonald grows crops worth $6,000. Farmer Brown’s land is on a swamp. Farmer Brown drains the swamp and can grow crops on his land worth $2,000. As a result McDonald’s land flood and destroys his crop. Example of not clear who pays is the swamp exampleTwo ways to resolve 1) M can pay B $4,000 not to drain the swamp. 2) Can pass a law against draining swamps without the agreement of any affected parties, which gives M the right to determine flood control upstream. Suppose the government invents a new crop so that Bs crop is worth $10,000. Now B should pay M $8000 for the right to drawn the swamp.

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? Optimal q=450 of the pollutant and MC=MB=180. If the farmer has the right to say how much to pollute, the company can offer up to $180 per unit of pollution to allow 450 units of pollution. The farmer also benefits from the first 450 units of pollution and receives $180 for each. Company pays B+C but gains A+B+C. Net profit is area A. If the company has the right to pollute, the would pollute 900 units. But the farmer could pay the company not to pollute paying up to $180 per unit for 450 units (area D+E). The farmer still incurs the cost of area C. The company’s net gain is A+B+C+D+E. Scenario 1) Farmer gains = B Company gains= A. Scenario 2) Farmer pays= D+E and suffers C. Company gains= A+B+C+D+E Both Scenarios) Net gain to society is $60,750

Upcoming in Class Group Quiz Next Thursday Writing Assignment Due Oct. 27th