Week 1: Intro. (anyone remember markets?) & valuation issues

the economy Firms (production) Households (consumption) InputsOutputs THE ECONOMY

the environment as an asset (environomy) Firms (production) Households (consumption) InputsOutputs THE ECONOMY Amenity valuesResource inputs Wastes Global life-support Impacts on biodiversity NATURE

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  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?

 but before we start measuring benefits and costs…  a review of markets…

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

demand  law of demand – ceteris parabis (With all other factors remaining the same) – if p ↑, QD ↓ if p ↓, QD ↑  demand curve downward sloping

$ Quantity demand

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

consumer surplus

benefits derived from demand  demand measures amount particular good people willing to purchase at different prices

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  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

supply  law of supply – ceteris parabis – if p ↑, QS ↑ if p ↓, QS ↓  supply curve upward sloping

$ Quantity supply

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

producer surplus

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  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  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?

$ Quantity MB = MC q* MB > MCMC > MB S = MC D = MB

MB = MC  If MB > MC, can increase quantity → increases benefits more than increases costs → total net benefits increase → 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!  net benefit: excess of benefits over costs  area under demand curve / above supply curve

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 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   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  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?   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

pv total benefit over all 200 years one time benefit (in yr. 200)

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  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?   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  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  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)

max net benefit, not b-c ratio Plan BenefitsCostsNet Benefits Benefit-Cost Ratio A1,200.01, B1,350.01, C1,475.01, D1,580.01, E1,682.01, F1,778.01,

simple benefit-cost excel example