ECON 335 Key Terms and Concepts

capital goods

capital goods

goods that last a long time, used to produce other goods and services (ie buildings or computers)

4 types of environmental services

natural resources, waste assimilation, life support, amenities

materials balance principle

based on the 1st law of thermodynamics, matter/energy cannot be created or destroyed — waste is inevitable, inputs = outputs

2nd law of theromdynamics

entropy is increasing, many processes are irreversible, some things cannot be created or destroyed

environmental quality

the level and consumption of the 4 environmental services. the corresponding value of EQ is the monetary value of the 4 ES

pollution

the reduction in environmental quality due to the disposal of wastes

benefit cost analysis

a model of benefits and costs at different quantities produced — benefit increases at a decreasing rate, cost increases at an increasing rate. Assumes that we are making a choice to maximize net benefit and that income is distributed in a socially acceptable way.

first theorem of welfare economics

absent market failures, the equilibrium of a competitive market is pareto optimal. maximum social welfare = consumer surplus + producer surplus = maximum net benefits

pareto optimum

a state in which it is impossible to make someone better off without making someone else worse off

pareto improvement

a change in which someone is made better off without making anyone else worse off

Utility Possibilities Frontier

a curve on which all points are pareto optimal

property rights

a bundle of entitlements that specify an owner’s rights, usage, and limitations to a resource

4 requirements for a system of property rights to ensure efficient outcomes

universality, exclusivity, transferability, enforceability

universality

clearly defined ownership, breakdown caused by open-access resources

exclusivity

all benefits and costs from the use of a resource accrue only to its owner, breakdown caused by externalities (technological and reciprocal/CPR) and public goods

transferability

all property rights are transferable through voluntary exchange

enforceability

property rights are secure from involuntary seizure or encroachment

market failure

a failure of competitive markets to produce efficient or pareto optimal outcomes

technological externality

when the action of an economic agent has a direct (uncompensated), unintentional effect on the welfare or wellbeing of another economic agent; does not pass through a market. Can be positive or negative.

pecuniary externality

an indirect (compensated) unintentional effect on the wellbeing or welfare of another economic agent; passes through a market; does not lead to market failure. Can be positive or negative.

deadweight loss

social costs that are greater than social benefits; missing out on a pareto improvement

theory of second-best

if there are multiple market failures, correcting just one of them may make society worse off instead of better off

private goods

rival and excludable

club/toll goods

nonrival and excludable

common goods

rival and nonexcludable

public goods

nonrival and nonexcludable

vertical summation

used to calculate the aggregate demand curve and obtain the marginal social benefit (MSB) curve of a public good. P = Pa+Pb at a given Q

private provision

where the private market provides/supplies a public good — leads to underprovision of the public good because of the free rider problem

free rider problem

an individual does not pay for a good because it has already been provided at the expense of another individual

reciprocal externality

caused by the tragedy of the commons, an externality imposed on other users of the resource

Common Pool Resources

goods that are rival and nonexcludable but have a limited number of users ausers face a set of rules and restrictions

open access resources

goods that are rival in use and nonexcludable, and are owned by no one. These lead to a breakdown in universality and the tragedy of the commons.

rents

profit at a certain quantity under private ownership, given by VTP(x) - TC(x) or the area under VMP(x) and above MC(x) before X*. Rents = 0 at the open access equilibrium (Xoa)

Open Access Equilibrium

where MB = MC in an open access scenario; rents = 0; given by VAP(x)=MC; akin to overexploiting a resource

coordination games (Game Theory)

players communicate and make binding agreements

non-coordination games (Game Theory)

players work in isolation

simultaneous-move games (Game Theory)

players make decisions at the same time

sequential-move games (Game Theory)

players make decisions at different times/taking turns

Prisoner’s Dilemma

a simultaneous-move, non-coordination game theory scenario in which all quadrants but (I) are pareto optimal and the dominant strategy equilibrium is to keep extracting a resource (leading to outcome (I) at the Xoa equivalent). By relying on this game, we assume that all OARs will result in the tragedy of the commons.

assurance game

a simultaneous-move, non-coordination game theory scenario in which there is no dominant strategy/equilibrium. Results in a Nash Equilibrium

Nash Equilibrium (NE)

a set of strategies in which there is no unilateral incentive to deviate from the agreement to stop consuming an OAR

government failures

intervention to correct a market failure that leads to the creation of distorted or improper incentives relative to what is socially desirable.

conditions for government intervention

1) there is a market failure

2) intervention must yield some benefits

3) benefits must exceed costs

types of government failures

1) unforseen/unanticipated consequences (ex New Source Performance Standards in the CAA discourage innovation gains)

2) piecemeal/successive government intervention (ex CWA followed by CAA led to a solid waste problem)

3) rent-seeking behaviors (ex lobbying)

4) subsidies (ex tarrifs, firms not paying costs of pollution)

rent-seeking behaviors

expending resources to benefit one individual or group at the expense of others by influencing legal or political decisions

subsidies

the most egregious government failure in terms of environmental degradation; a government-directed, market-distorting intervention which decreases the cost of production or increases the consumer-price of a good or service. Can be justified (redistributive tax credits or investment in renewables) or unjustified (protectionism or subsidizing fossil fuels)

distortions or misallocations caused by subsidies

1) overcapitalization effect

2) technology effect

3) resource inefficiency effect

4) public resource deprivation effect

overcapitalization effect

more investment in a sector than there would be without the subsidy (ie corn subsidies)

technology effect

use of technologies that are harmful to the environment (caused by fossil fuel subsidies)

resource inefficiency effect

not paying for a resource leads to less incentive to conserve that resource (ie water subsidies)

public resource deprivation effect

selling public domain resources at lower costs deprives the public of financial benefit (ex logging on federal land for cheaper than private market cost of lumber)

microeconomic costs

firm-level costs of compliance, estimated using information reported to the government or data on revenues and costs (to estimate lost profits). deficiencies include: biased estimates, firms may not be able to distinguish between environmental and production costs, accounting costs may not coincide with true economic costs

macroeconomic costs

effects on economic productivity, employment, investment (displaced overseas)

production/market benefits

value exchanged in private markets

individual/nonmarket benefits

direct value to an individual; include use-value and nonuse value (option value and existence value)

total benefits calculation

TB = production value + use value + option value + existence value

the greatest value in terms of calculating benefits

existence value (snail darter example)

stated preferences approach

a means of evaluating benefits by asking consumers their willingness to pay

revealed preferences approach

a means of evaluating benefits by observing behavior in related markets to infer willingness to pay

contingent valuation

survey-based method to reveal WTP, the only method that can estimate non-use value. Used in stated preference approach.

hypothetical bias

the most important bias from CV, respondents faced with a contrived set of choices may not respond accurately.

conditions for truthful reporting

incentive compatibility and consequentiality — if not met, the WTP is overestimated; if met, the WTP is underestimated

incentive compatibility

belief that your response matters and will be taken into account

consequentiality

belief that provision determined by responses will impact wellbeing

information bias

bias in CV, respondents are not fully informed of the benefits and costs of an action

vehicle bias

bias in CV, related to how an action is being funded (tax vs individual fee)

embedding bias

bias in CV as a result of the order in which the question was asked (whatever is shown first is estimated to be of higher value)

scope bias

bias in CV either towards a large scope of preservation (increase in WTP) or people are willing to pay less per unit for a bigger impact

4 main methods of revealed preference approach

travel-cost method, hedonic-housing price method, hedonic wage rate method, defensive expenditures method

travel cost method

infers marginal WTP for environmental quality from travel decisions. assumes that changing an entry fee has the same impact as changing travel costs and that if people travel to a park then benefits>costs.

hedonic housing price method

used to estimate marginal WTP for environmental quality — differences in housing prices should reflect differences in EQ so long as all other differences are controlled for

hedonic wage rate method

estimates marginal WTP for reduced exposure to environmental hazards using wage rates to reflect differences in EQ. Issue: no two occupations are the same in all other aspects

defensive expenditures (averting behaviors)

relies on purchased inputs to mitigate effects of pollution, ex. people buy bottled water to avoid contaminated water. WTP = price/input(number of inputs bought after contamination - number of inputs bought before contamination)

value of a statistical life (VSL)

what a group is willing to pay for a reduction in risk of mortality/morbidity by the equivalent of one or more premature death

VSL formula

marginal WTP/change in risk OR total WTP/change in premature deaths

net benefit criterion

the preferred policy is the one with the highest net benefit. if there is only one policy, it is accepted only if net benefits are positive

putting environmental benefits or costs in monetary terms cheapens the worth of the environment BUT

if we don’t put a price on the environment then we will have ill-informed tradeoffs

BCA ignores the losers from a policy BUT

the Kaldor-Hicks Compensation Criterion says that if winners can compensate the losers and both groups are still better off than before, then a policy is still desirable

4 borad waste abatement methods

1. change in production technology

2. change in inputs

3. change in output (reducing quantity, changing product type)

4. installation of end-of-pipe technology

types of pollutants are grouped by

1. assimilative capacity (how much the environment can abate on its own)

2. horizontal zone of influence

3. vertical zone of influence

stock pollutant

a pollutant that the environment has little to no assimilative capacity for

flow pollutant

a pollutant that the environment has some assimilative capacity for (up to a certain point)

local pollutant

a pollutant that doesn’t move from its source

regional pollutant

a pollutant that moves from its source

surface pollutant

a ground-level pollutant

global pollutant

an atmospheric pollutant

marginal abatement cost (MAC) as it moves from left to right

marginal benefit to the firm

marginal damages (MD) as it moves from right to left

marginal benefit to society

MAC as it moves right to left

marginal cost to society

MD as it moves from left to right

marginal cost to the firm

coase theorem

if property rights are well-defined, the private market can achieve the socially optimal level of wastes (w*) through bargaining (without government intervention)

command and control

a policy instrument in which governments command firms to control their output, generally by enforcing standards

market-based approach

a policy instrument in which actions are incentivized using market mechanisms

information-based approach

combines market based and command-control strategies

total cost equation with standards

= AC = area under MAC to w*

total cost equation under a tax

= AC(w*) + tw*

total cost equation under a subsidy

= AC(w*)-sub*(ŵ-w*)

policy instrument profits

Π(t) < Π(stnd) < Π(no reg) < Π(sub)

regulator’s problem

how much do we allow each firm to emit so that:

1) w1 + w2 = wT*

2) sum ACt = AC1 + AC2 is minimized

in other words: how to minimize the total abatement costs for both firms

regulator’s solution

choose w1 and w2 such that MAC(w1) = MAC(w2)