Studied by 71 people
Generally, people prefer benefits to happen
sooner rather than later
People prefer costs to happen
later rather than sooner
Discounting formula
PV = FV / (1 + r)^t
_____ is your willingness to accept to wait one year to be paid.
PV * r
We normally expect PV * r to be
positive
We call F the ____
future value
Discount rate
the value of r that satisfies the equation, a measure of the rate at which a person discounts net future benefits
Discounting
the idea of valuing future net benefits less than if they occurred now because they occur in the future
Unless stated otherwise, assume it's an ____ discount rate
annual
A higher discount rate signals
the person values current net benefits more than a person with a lower discount rate
Present value
the amount which if the person received it today, would make him just as well off as if he waited to receive the higher amount.
In this course, we will mainly be interested in the
present value of things happening in the future
For net benefits occurring multiple time periods in the future, we need to
discount back for each time period
The discount rate is
personal
When thinking about actions that affect the environment, we usually think of
larger scale projects or policies
Two important criteria for how economists think about whether decisions/actions that affect many people are a good idea or not
Pareto Criterion and Potential Pareto Criterion
Pareto Criterion
a policy makes society better off only if it makes at least one person better off and it makes nobody worse off
Which criterion is too strict?
Pareto Criterion
Potential Pareto Criterion
a policy makes society better off only if the gains to those made better off by the policy are greater than the losses to those made worse off by the policy
T or F: The compensation from the Potential Pareto Criterion always happens.
F
The PPC is conceptually the same as
the total benefits being greater than the total costs
The distribution of net benefits is not considered for the PPC, but it can be important for assessing the
desirability of the policy
You could have a policy that looks like a good idea according to this criterion, but maybe its harms a particular population disproportionately and that isn't __________.
politically acceptable
Benefit-Cost Analysis
the process of assessing benefits and costs of an action, while accounting for when the benefits and costs occur, in order to determine whether an action is a good idea or not
BCA supporters say
it helps support decision making
BCA detractors are
skeptical of assessing environmental issues in dollars and it reduces the flexibility of policy choice
BCA two main uses
to judge the desirability of a proposed action before it is implemented
to assess the performance of a past action after it has been implemented
With or without priniciple
to determine whether an action is good or not, one must compare the world with the action in place to the world without the action in place
Post hoc ergo propter hoc
A common error when you compare the world before and after the action takes place, its an error because you could attribute changes to the policy that would have happened anyway
Final output of BCA is called
Present Value of Net Benefits
Ten Steps in Calculating PVNB
Scoping, Determine the benefits per unit of output, Determine the costs per unit of output, Determine the output quantities per time period, Determine the input quantities per time period, Calculate the benefits per time period, Calculate the costs per time period, Calculate the net benefits per time period, Assume a discount rate and calculate PVNB, Compare policy possibilities and decide what to do
What can greatly affect the PVNB?
the discount rate
If there is only 1 proposed policy, adopt if
PVNB > 0
If there’s more than 1 policy that has PVNB > 0 and they are mutually exclusive, adopt
the policy with the highest PVNB
Cost-Effectiveness Analysis
an analysis to determine the least-cost way of achieving some objective, often done when the objective is already specified
The least-cost approach is achieved by the
equi-marginal rule
Equi-marginal rule
use each means of reaching the goal such that the marginal cost of getting incrementally closer to the goal is equal across all means of reaching the goal
Since MC tends to increase, eventually,
another means becomes a cheaper way to make progress
Assuming its optimal to use some combination of all the different means, the least-cost way of reaching our goal occurs when
MC1 = MC2 = MC3 … where MC is the cost of increasing average lifespan by a small amount and the subscripts denote different means of making progress towards the goal
If not all means are used, ___
there may be some inequalities
A limit of CEA
it doesn’t account for benefits, so you don’t know if benefits are greater than costs
Like BCA, CEA can
be expanded to account for time (discounting)
Discount rate is _____, it’s different for everyone.
Personal
Even though the discount rate is different for everyone, for policy analysis, we need to
pick one value
Strategies for choosing a discount rate to use in economic analysis
Set the discount rate equal to the interest rate
Use the rate at which the government borrows money
Use the social opportunity cost of capital
Conduct economic experiment
Potential weakness for the “set the discount rate equal to the interest rate” strategy for choosing a discount rate in economic analysis
preferences of people may not be accurately represented by an interest rate
Potential weakness for the “use the rate at which government borrows money” strategy for choosing a discount rate in economic analysis
private opportunity costs are generally much higher than for government opportunity costs
What is the estimated return on investment for social opportunity costs of capital?
7%
Choosing a discount rate is largely
a judgement call
If your conclusions are the same over a wide range of discount rates, ___
we feel more confident about the conclusions
Very distant costs and benefits can have a PV that’s nearly
$0
It is psychologically more difficult to justify
not addressing catastrophes
non-renewable energy sources
oil, coal, natural gas
User-Cost
the opportunity cost of extracting a unit in one time period instead of another, the maximum present value of profits forgone on that unit from extracting now rather than at some other time
MCt =
MCtd + Ut
MCt
total marginal extraction costs at time t
MCtd
conventional marginal extraction costs like removing oil from the ground
Ut
user cost of extraction
An action affects 2000 people. 1000 of these people are made better by $30 each. The other 1000 people are made worse off by $18 each. True or False: This action meets the potential Pareto criterion.
True
Suppose that 6 months into virus pandemic, the average number of deaths per week from the virus in the city of Storkville is 8, and, until this point, there has been no mask mandate in place.
The city of Storkville then decides at that time to impose a mask mandate.
6 months later, the average number of deaths per week from the virus in the city of Storkville has fallen to 5.
True or False: The officials of the city of Storkville can conclude that the decrease from 8 to 5 of the weekly average deaths was a result of the mask mandate.
False
It is estimated that a proposed project has net benefits of -$4 million occurring one year from now and +$4.5 million occurring two years from now.
Which of the following best describes the present value of net benefits (PVNB) of this project?
PVNB > 0
PVNB < 0
Not enough information is given to determine whether PVNB is greater than or less than 0.
Not enough information is given to determine whether PVNB is greater than or less than 0.
It is estimated that a proposed project as net benefits of -$1000 occurring today and +$1500 occurring 3 years from now. The researcher assumes a discount rate of 5%. What is the correct equation for the present value of net benefits of this project?
PVNB = -1000 + 1500/(1.05^3)
Static model
no time
In a static model, if a firm is maximizing profit, at that level of production, _______.
MR = MC
In a dynamic model, we assume the firm wants to maximize its
intertemporal profit
Intertemporal profit
profit across time
A firm is maximizing its intertemporal profit if, at the quantities produced in each time period, ______
the present value of the user costs are equal across all time period
Hotelling’s Rule
if the direct marginal costs of extraction, MCtd, are nearly 0, then Ut = Pt, so prices will rise at the discount rate
Some things that affect the price path
the size of the resource base, the presence of a backstop fuel, the discount rate
backstop fuel
an alternative source of fuel which sees increased use when the price of another source gets too high
Coal
non-renewable, higher sulfur content which leads to SO2 emissions, high mercury content, and CO2
Uranium
non-renewable, nuclear power, main issue is risk of accident, problems with nuclear meltdown and how to store waste, waste is radioactive and has a long half-life
Hydroelectric power
renewable, convert energy from flowing water into electricity by building a dam, relatively clean environmentally, can be harmful on other ways like affecting fish migration, negatively affects downstream usage, and can flood upstream ecosystems
Wind
renewable, convert flowing air into electricity, big tech advances in recent years, eyesore (especially offshore turbines), killing birds and bats
Photovoltaics
renewable, converts sunlight into electricity, more economically feasible, more feasible for locations, off the electrical grid, disposal of solar panels involves disposal of toxic materials, big challenge is how to make storing energy when it isn’t sunny more economically feasible
Biofuels
renewable, convert decomposing plant material (corn, sugar, switch grass, wood, etc) into electricity, ethanol, methanol, biodiesel, some sources are not very energy efficient
Note 
Flashcard (63)