AEC 3233 Exam 3 Matthew Interis Spring 2023

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

1. to judge the desirability of a proposed action before it is implemented

2. 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

1. Set the discount rate equal to the interest rate

2. Use the rate at which the government borrows money

3. Use the social opportunity cost of capital

4. 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