ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. C H A P T E R 18 MANAGING RISK AND UNCERTAINTY

ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. FIGURE 18.1 Subjective estimates of risk versus true risk for group of 40 subjects. Note: Data points are geometric means of estimates of risk from a group of 40 subjects told that there are 50,000 motor vehicle accidents per year in the United States. Frequencies are deaths per year in the United States. (From Slovic, et al., 1979.)

ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. FIGURE 18.2 Expected utility. x A, payoff with probability π A ; x B, payoff with probability 1 – π A ; EP, expected payoff = π A x A + (1 – π A ) x B ; EU, expected utility from risk; CE, certainty equivalent of risk; RP, risk premium = EP – CE.

ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. FIGURE 18.3 Willingness-to-pay locus for risk reducing investment. OP, option price; ES, expected surplus; OV, option value; (VL,VS), state-contingent surplus from risk reducing investment.

ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. FIGURE 18.4 Demand and supply for maize, with surplus from genetic discovery. ABCD, surplus gain from lowered supply curve.

ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. FIGURE 18.5 The socially optimal amount of precaution. MED(x), marginal expected damage; MC(x), marginal cost of precaution; x*, efficient amount of precaution.

ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. FIGURE 18.6 Total costs under a negligence rule. C(x), costs of precaution; ED(x), expected damage to victim; x*, socially optimal level of precaution.

ENVIRONMENTAL ECONOMICS – 2e Charles D. Kolstad Copyright © 2011 by Oxford University Press, Inc. FIGURE 18.7 Illustration of joint use of liability and direct regulation. x*(D), optimal level of precaution; x R, optimal level of precaution with direct regulation; x L (D), precaution provided by liability; x RL (D), precaution with joint use of liability and direct regulation. Book