 Homework #1 Due Thursday  Group Quiz Next Thursday  Writing Assignment Due Oct. 28th

Price of Good Quantity of Good Marginal Cost Marginal Benefit Equilibrium Price 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

 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 Quantity of Good Supply Demand Equilibrium Price Equilibrium Quantity

Price of Good Quantity of Good Supply Demand Equilibrium Price Equilibrium Quantity

Price of Good Quantity of Good Supply Demand Equilibrium Price Equilibrium Quantity

Price of Good Quantity of Good Supply Demand Equilibrium Price Equilibrium Quantity

Price of Good Quantity of Good Supply Demand Equilibrium Price Equilibrium Quantity

 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

 Common Goods – rivalrous, non- excludable  Public Goods – non-rivalrous, non- excludable

 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

 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.

 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 benefit when five smart-grid meters are installed?

 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.

 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)

Price of Good Quantity of Good Supply Demand Equilibrium Price Equilibrium Quantity

Price of Good Quantity of Good Marginal Private Cost Demand Market Price Market Quantity Marginal Social Cost Q* P*

 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 P d = 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 P s =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?

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

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?

 Homework #1 Due Thursday  Group Quiz Next Thursday  Writing Assignment Due Oct. 28th