AGEC/FNR 406 LECTURE 14 Pesticide Runoff Potential from Field Crops

Correcting market failures Static efficiency is obtained when net benefits for a single period’s are maximized. If private efficiency does not equal social efficiency, then we have market failure. Intervention may be justified, and many approaches are available. What is the “best” way to correct the market failure?

Marginal damage function Dollar measure of incremental damage from pollution Q of Emission E Damages MD Total Damage D

Important cases 1. private benefits = social benefits private costs = social costs (no market failure) 2. private benefits = social benefits private costs NE social costs (positive or negative externality) 3. private benefits NE social benefits private costs = social costs (positive or negative externality)

Case 1 private benefits = social benefits private costs = social costs Q Q* P* PMC=SMC PMB=SMB

Case 2 private benefits = social benefits private costs NE social costs SMC = PMC + MD Q Q P PMC PMB=SMB Q* P* MD

Case 3 private benefits NE social benefits private costs = social costs Loss in Benefit Q Q* P* PMC=SMC SMB Q P PMB

Possible interventions 1. Moral suasion 2. Government provision of goods 3. Damage prevention 4. Command and control 5. Economic Incentives

Deriving values for non-market goods Two conceptual approaches to valuation 1. Revealed preference 2. Stated preference

Revealed preference approaches Hedonic pricing price attributed to characteristics of a good Hedonic wages accepted wages reflect tradeoffs such as risk and living conditions Travel cost the value of a recreation site reflects the cost people willingly pay to get to it

Stated preference approach Contingent valuation use a survey to measure willingness to pay regarding actual or hypothetical changes in the environment

Example 1: Hedonic wage Construction work is risky, and the riskiest jobs have wage premia. What if workers are willing to accept a 1/1000 annual risk of death to take a job that pays $1200 more per year? What is the value of one “statistical life”?

Calculating the hedonic wage Workers are willing to accept a 1/1000 annual risk of death to take a job that pays $1200 more per year. $1,200 * 1000 = $1,200, people have a collective willingness to accept $1.2 million to be exposed to the death of one individual.

Example 2: Travel cost model 5 people 1 recreation site {A,B,C,D,E} A B C D E

Visitation data IndividualCost# visits A 0 50 B C D E250 0

Construct a demand curve 50 Travel Cost P = Q 0 Number of visits 0 D 250 C B A E Individual Cost# visits E D C B A 0 50

1. consumer surplus (TB) 50 Travel Cost P = Q 0 Number of visits 25 0 D 250 C B A E Demand curve can be used to find: 2. impact of increased fees