Lecture 2: Introduction + Discounting

What does natural resource economics study?

  • How should we use natural resources over time?

  • Do we have adequate amounts of natural resources?

  • When do markets and institutions allocate natural resources as well?

  • Natural resources include fossil fuels, groundwater, surface water, fisheries, forests, wildlife, minerals, etc.

  • Natural resource policy and management issues

Why would you want to study natural resource economics?

  • Interested in how we should use natural resources over time, based on the costs and benefits.

  • Interested in participating in public policy discussions about natural resources.

  • Want to work in a job that addresses natural resources or the enviornment.

What distinguishes natural resource economic analysis from other types of economic analysis?

  • Framework for analysis is microeconomic principles

  • Natural resource problems focus on the allocation of resource stocks over time.

  • Natural resource economics requires dynamic (over time) analysis

  • It asks Normative questions (e.g., how should we manage a resource) as opposed to positive questions (e.g., how people are managing a resource?).

Learning Objectives

  • Identify the effect of discounting on costs and benefits that occur
    at different points in time

  • Determine the present values of a stream of benefits and costs

  • Determine net present values of alternative projects

Discounting and cost benefits analysis

  • Answering the question “Which project would you recommend?” can be answered by conducting a cost-benefit analysis.

  • If costs and benefits occur at the same time, then one way to inform the descion is based on whether benefits outweigh costs.

  • However, when costs and benefits occur at different points in time, can we compare them?

    • In other words, are $1 today and $1 three years from now equivalent?

    • Nope! Here's why:

      • Studies on ‘time preference’ shows that people put a higher value on an outcome experience today than they do on the promise of the same outcome at some time in the future.

      • Relatedly, when future outcomes are uncertain, they are undervalued today.

  • One way to account for the fact that a dollar today is more valuable than a dollar tomorrow is to discount future dollars.

  • To do so, one can divide values by a number that is greater than 1, say, (1+r) where r is a discount rate between 0 and 1.

    • $1 a year from now = 1(1+r)=11+1.02=0.98\frac{1}{\left(1+r\right)}=\frac{1}{1+1.02}=0.98

      when r = 2%.

    • Another way to say it is that $1 in one year has a value of $0.98 today for someone with a discount rate of 2%.

      • $1 in one year= future value

      • a value of $0.98 today = present value.