econ ch 6

Benefit cost ratio

the ratio of total benefits to total costs, indicating how many dollars of benefits are generated for each $1 of cost.

Net benefits

Total benefits minus total cost

Net present value

This is the most common investment criteria used by economists.

•It involves discounting future values (both benefits and costs) to the present.

   - The higher the discount rate, r, the lower the PV

Importance of discount rate

Discount converts future net benefits into PV

• Project outcomes can change depending on disc rate chosen

Present value and discounting

Many costs and benefits occur in the distant future.

Future costs & benefits must be discounted

General formula for discounting is

Present value = m/(1+r)t

Benefit cost analysis

A tool used to support public decision-making by evaluating which policies or programs should be implemented from the perspective of society, ratherthan that of a single profit-maximizing firm.

- Considers the social value of all costs and benefitsassociate a with a project.

- Includes impacts not traded in private markets (e.g., environmental and social effects).

BCA short definition

compares the total benefits and total costs of a public project or policy to evaluate its value.

Total benefits

Total damages reduced (area under the MD curve).

Total costs

Total abatement costs (area under the MAC curve).

Max net benefits occur where

MAC = MD (the intersection of the curves).

Net benefits

Benefits - costs

If NB ≥ 0

the policy is economically justified.

If NB < 0

Policy is not economically justified

Importance of discount rate

Discounting converts future net benefits into present value

- Project outcomes can change depending on the discount rate chosen

Low discount rate

Future dollars ≈ today’s dollars

- Favors projects with long-term benefits

High discount rate

Today’s dollars ≫ future dollars

- Favors projects with short-term payoffs

Horizontal equity

treating similarly situated

people the same way

Vertical equity

Treating people in different

situations differently

Proportional

The net benefits to each person in

proportion to their income is the same

Regressive

The program provides higher net benefits

to high-income people than to low-income people as a

proportion of their income

Progressive

The program provides net benefits that

represent a higher proportion of the lower-income

person’s income than it does of the rich person’s income

Risk incorporates three main considerations:

Probability of a bad outcome.

Consequences of a bad outcome.

Cost of dealing with a bad outcome.

Expected value i

the number of times the event

occurs X its probability of occurrence, summed over

all possible events.

Risk assessment

a structured process used to identify, analyze, and evaluate potential harm to the

environment caused by human activities, chemicals, projects, or natural events.

Hazard identification

Determine what environmental harm could occur.

• E.g.: toxic chemicals, air pollutants, habitat destruction, oil spills

Exposure assessment

Estimate how much of the hazard reaches the environment and how

often.

• E.g.: Measuring chemical concentrations in a river downstream of a

factory.

Risk characterization

Combine exposure and effects to determine overall environmental

risk.

• Risk is often expressed as:

EFFECTS ASSESSMENT (DOSE-RESPONSE ASSESSMENT

Evaluate how organisms respond to the exposur

Risk management

the decision-making process of evaluating and choosing from

alternative responses to environmental risk

Expected value

Sum (NPV x Probability) for each State of nature