Environmental economics: Chapter 3 & 4

Question 1

The anthropocentric approach

Answer 1

The anthropocentric approach means that these measurements are based on their impact on human well-being and preferences, considering how changes affect people’s lives, health, or economic opportunities.

Question 2

Opportunity cost

Answer 2

Refers to the value of the alternative choice that is foregone when a choice is made. In other words, it’s the benefit you give up by choosing one option over another. This concept is fundamental in economics because it helps to evaluate the true cost of decisions by considering what is sacrificed when resources are allocated in a particular way.

for example take the bus VS the car?

Question 3

Net benefit

Answer 3

It is calculated as the difference between the total benefits and total costs associated with that action.

Question 4

How can a cost-benefit-analysis be used?

Answer 4

For example: Fisheries Depletion: Economists define the “optimal stock” (ideal amount of fish left to sustain biodiversity and fishing industries), then compare it with actual levels.

They find over-exploitation as the main problem, and based on this analysis, policies are created to restore balance.

Question 5

What is The First Equimarginal Principle?

Answer 5

Imagine you’re painting a fence. For each extra hour you paint, the fence looks better (that’s the benefit), but you also get more tired and use more paint (that’s the cost). The First Equimarginal Principle says you should keep painting as long as the improvement to the fence is happening at the same rate as the cost in tiredness and paint. When it starts to be less worth it to keep painting compared to the cost (i.e., when it costs more than it makes the fence look better), then it’s time to stop.

Question 6

Pareto Optimal

Answer 6

It helps us determine whether resources are being allocated in the most efficient way possible. It refers to a situation where it is impossible to improve one person’s situation without worsening someone else’s situation. In other words, a resource allocation is considered Pareto optimal when no one can be made better off without making someone else worse off.

Suppose Alice has 3 slices and Bob has 3 slices. If we can find a way to give more slices to Alice without reducing Bob’s share, we would be making a Pareto improvement.

Question 7

The importance of present value

Answer 7

It focuses on the idea that money today is worth more than the same amount in the future due to interest. To account for this, economists use discounting, where future benefits and costs are converted into present terms. The formula for present value discounts future amounts based on an interest rate.

Question 8

Social cost in cost-benefit analysis

Answer 8

For example, agencies use the “social cost of carbon” to estimate the economic damages caused by carbon emissions. Rising sea levels, food scarcity and so on.

Question 9

Issues of cost-benefit-analysis

Answer 9

• Hard to tell the Primary vs. Secondary Effects
• Location matters, not the same everywhere
• With and Without Principle: If analysts do not accurately apply this principle, they might overestimate the benefits of a project by including improvements that would have occurred naturally, regardless of the project.
• Even though intangible benefits are difficult to measure, they should still be considered in the analysis because they can significantly influence public perception and quality of life.
• Fluctuating prices?

Question 10

The survey approach and its problems

Answer 10

• Involves gathering information from entities that would incur costs, such as polluters or businesses affected by regulations
• Gather data on how much they expect to spend or the costs they anticipate incurring.

Issues:
- Respondent bias, overestimating costs, reporting higher costs, skewed data.
- Downplaying cost to receive incentives or support.
- Sample of respondentens, certain types of companies are more likely to respond.
- Costs are complicated, respondentens can have a hard time calculating, creating false statistics
- issues about the time-frame

Question 11

The Engineering Approach and its problems

Answer 11

Involves estimating costs by evaluating the technological and engineering solutions needed to achieve particular goals or compliance with regulations.

Engineers assess the technical requirements of a project, including the design, materials, and processes needed.

Provide objective analysis since it based on research and calculations and not on subjective opinions.

Issues:
- not representing the actual costs in real-world, represent ideal-situations. Lack of local labor costs and so on.

• Different firms and varying contexts, levels of expertise, and existing technologies. As a result, the estimated costs based on an engineering model may not apply uniformly across all firms.
• The cost of materials, labor, and technology can fluctuate due to market conditions, but the Engineering Approach may rely on static estimates that do not account for these changes.
• Assumes full compliance by firms, which is not the case in all situations.

Question 12

The combined approach

Answer 12

Refers to a methodology that integrates multiple techniques to arrive at a more comprehensive and accurate assessment of costs associated with a project or regulation. This approach typically combines elements from different estimation methods, such as the Engineering Approach, Survey Approach, and other analytical frameworks.

Issues
- more complex and time consuming
- Resource intensive
- Potentially conflicting results
-

Question 13

The treatment of Risk

Answer 13

Environmental policies often face uncertainty about their outcomes. Analysts need to identify and quantify risks and assess how much risk is acceptable.

• When multiple outcomes are possible for each policy option, one with the highest net benefits in all outcomes—may be chosen if it exists.
• If not, analysts calculate the Expected Present Value of Net Benefits (EPVNB), which weighs each policy outcome by its probability of occurrence.

Question 14

Risk preferences

Answer 14

The statement addresses how different people respond to risk when making decisions.

Question 15

Risk-neutral

Answer 15

A risk-neutral individual is indifferent between a sure outcome and a risky lottery with the same expected value. This means they do not have a preference for certainty over uncertainty if the average outcome is the same.

• Since the expected value of the lottery ($50) is equal to the sure outcome ($50), a risk-neutral person would be indifferent between the two options.
• In public policy, risk-neutrality is often assumed for decision-making, based on the idea that the government can spread risk across the entire population, making the cost of risk-bearing insignificant.

Question 16

Risk-Loving

Answer 16

A risk-loving individual prefers the lottery over a sure outcome, even if the lottery has the same expected value. This person is willing to take on more risk for the potential of higher rewards.They find excitement in the gamble and are motivated by the possibility of a larger payoff.

Question 17

Risk-Averse

Answer 17

A risk-averse individual prefers the sure outcome over a lottery with the same expected value. This person values certainty and is willing to give up some potential gain to avoid risk.

Question 18

Distribution of Benefits and Costs

Answer 18

Economic impact analysis:
- A broad analyze of who gains and who loses from a given policy.

Equity analysis:
- Impacts on disadvantaged groups or sub-populations.

Question 19

Why is discount rates important?

Answer 19

Discount rates allow comparison of costs and benefits over time. A higher discount rate reduces the present value of future benefits, potentially discouraging long-term investments, while a lower rate increases the attractiveness of projects with long-term payoffs.

Question 20

Issues with discount rates

Answer 20

• To avoid manipulation in evaluations of public projects, the U.S. government established standardized discount rates for benefit-cost analysis.

-The standardization provides consistency, but can lead discount rate does not reflecting social opportunity cost of capital. Refers to the true cost of forgoing alternative investments or opportunities when allocating resources to a specific public project.

• If the social opportunity cost is lower than the standardized discount rate, projects that are beneficial in the long term may be undervalued and thus inadequately funded.

Question 21

Private discount rates

Answer 21

This rate is used by firms and individuals to evaluate the present value of future cash flows or benefits. It reflects their specific circumstances, including their risk tolerance, investment horizons, and expected returns on investment.

Question 22

Social discount rate

Answer 22

This rate represents the societal perspective on valuing future benefits and costs. It is often lower than the private discount rate because it considers broader social welfare, long-term sustainability, and intergenerational equity.

Question 23

How are social and private discount rate connected?

Answer 23

• For resources to be allocated efficiently, firms should ideally use a discount rate that aligns with the social discount rate. When both rates are the same, it ensures that the extraction and consumption of resources reflect the true value of those resources to society.
• If firms use a higher private discount rate than the social rate, they may undervalue long-term benefits and over-extract resources in the short term. This can lead to overconsumption and depletion of resources, causing negative externalities (like environmental degradation) that society must deal with later.
• if the social discount rate is significantly lower, it may encourage investments in projects that yield long-term benefits but may not be prioritized by private firms due to immediate profit concerns.

Question 24

Risk premiums

Answer 24

A risk premium is an additional return that investors require to hold a risky asset compared to a risk-free assets.

Firms may apply a higher discount rate due to perceived risks such as the potential for government actions, regulatory changes, or market volatility. For example, if a company fears that the government might confiscate its assets or impose heavy taxes, it might inflate its discount rate to account for this risk.

Question 25

Time preference

Answer 25

Time preference refers to the relative value placed on present benefits compared to future benefits. It reflects how much people or organizations prefer immediate gratification over delayed gratification.

Private entities may have a higher time preference because they focus on short-term profits and returns, while public sector decisions often account for long-term societal benefits.

Developing countries often prioritize immediate needs and challenges, which leads them to place a higher value on getting benefits now rather than later. In contrast, industrialized countries tend to focus more on long-term benefits.

Question 26

Cost-Effectiveness Analysis

Answer 26

• CEA is a way to evaluate different options when we don’t have clear information about benefits and costs. Instead of comparing the two directly, it helps set goals for policies.
• Researchers study how pollutants affect human health and determine the highest amount of pollution that is still safe for people. This means they find levels of pollutants that can be allowed while keeping a buffer to protect public health.
• For instance, if a study finds that a certain level of pollution can harm health, CEA helps set a limit on how much of that pollutant can be in the air or water. This limit is established to ensure people remain safe from health risks.
• Policymakers are encouraged to use BCA in conjunction with other analytical methods, such as cost-effectiveness analysis, to make informed decisions that account for both economic efficiency and social equity.

Question 27

Impact analysis

Answer 27

• Impact analysis is a way to figure out how a new project or policy will affect people, the environment, and the economy.
• Decide What to Study, Gather Information:

Building a New Highway:
Environmental Impact: Check how the highway might affect nearby animals and plants.
Economic Impact: See if it will help people get to jobs faster or if it will change property values.
Social Impact: Think about how it will affect local communities, like increased traffic or changes in access to stores and schools.

Question 28

Static Efficient Allocation

Answer 28

• Refers to how resources are distributed at a specific point in time. It focuses on making the best use of available resources without considering changes over time.
• It ensures that resources are used in a way that maximizes benefits without waste. For example, if a factory produces shoes, static efficiency means using the right amount of materials and labor to produce the maximum number of shoes without overproducing or underproducing.

Question 29

Dynamic Efficient Allocation

Answer 29

• Dynamic efficient allocation, on the other hand, considers how resources should be allocated over time. It focuses on maximizing benefits not just in the present, but also in the future.
• Dynamic efficiency involves making decisions that consider future needs and changes. It takes into account factors like population growth, technological advancements, and environmental impacts.
• It may involve investing in resources today to create more value in the future. For instance, spending money to research and develop new technologies can lead to greater efficiency and productivity later on.

Question 30

What could be the challenges in assessing?

Answer 30

Ethical Issues: It’s not possible to do experiments where people are intentionally exposed to pollution, would be unethical. This makes it difficult to study the direct effects of pollution on humans.

• Scientists sometimes study the effects of pollution on animals to get an idea of how it might affect humans. But animals the same, weird results.
• Animal studies raise ethical questions about causing harm to animals.
• Causation Challenges: When studying human populations, it’s hard to prove that pollution is the direct cause of health problems because many other factors could also play a role.

Question 31

Why is it difficult to put a monetary value on damages like extending a life or suffering from illness?

Answer 31

• It’s challenging to decide how much a human life is worth in dollars because life and health are invaluable. There is no clear way to measure the true value of extending someone’s life or improving their health.
• Suffering from an illness or the loss of a loved one involves a lot of emotional pain, which isn’t something that can easily be expressed in monetary terms. Putting a price tag on such experiences feels insensitive or impossible
• Different views on what makes life valuable or what an acceptable level of risk is. Some might value reducing the risk of illness more than others, making it hard to come up with a standard monetary value for health improvements.
• The impact of an illness or extending life can differ widely depending on the person’s age, quality of life, or specific situation. This variation makes it difficult to set a general value that applies to everyone.

Question 32

Different types of value

Answer 32

Use Value: This reflects the direct use of environmental resources (e.g., fish, timber) and can decrease due to pollution.

Option Value: Represents the value people place on the ability to use the environment in the future, even if they are not currently using it.

Nonuse (Passive-Use) Values: Bequest Value: Willingness to pay to ensure resources are available for future generations. Existence Value: Satisfaction derived from knowing a resource exists, independent of any current or future use.

Question 33

Total willingness to pay

Answer 33

The total willingness to pay is the sum of use value, option value, and nonuse value, reflecting a comprehensive valuation of environmental resources.

Question 34

Compensating variation
Positive compensation variation
Negative compensation variation

Answer 34

A measure of the amount of money people would need to compensate them to avoid/achieve a negative/positive change in their well-being due to a change in the quality of a good or service—in this case, environmental quality.

Means people are willing to pay for an improvement in their well-being (such as an improvement in environmental quality).

Negative CV, means people are willing to pay to avoid a negative outcome, to accept a decline in their well-being (such as a deterioration in environmental quality).

Question 35

Equivalent variation

Answer 35

EV refers to the amount of money a person would be willing to pay (or accept) to avoid a change in their welfare (such as a price increase) or to gain a change in welfare (like a price decrease). It quantifies how much money would make the individual indifferent between the original situation and a new situation with the price change

Question 36

Willingness to pay

Answer 36

Measures how much money people are willing to pay to obtain some improvement in a good or service, like cleaner air or a restored ecosystem. It represents the value they place on an improvement.

Question 37

Willingness to accept

Answer 37

Measures how much people would need to be compensated to accept some loss or decline in the quality of a good or service. It represents the value they place on avoiding deterioration.

Question 38

How are positive and negative CV, WTP and WTA interconnected?

Answer 38

A positive CV indicates WTP, and a negative CV indicates WTA. For environmental quality, positive CV reflects WTP for improvement, and negative CV shows WTA for deterioration.

Question 39

What does it mean if the equivalent variation is positive or negative?

Answer 39

If the Equivalent variation is positive, it indicates that the individual would require compensation (Willingness to accept) to endure the price increase. Conversely, if the Equivalent variation is negative, it indicates that the individual is willing to pay (Willingness to pay) to avoid the price increase.

Question 40

Contingent valuation

Answer 40

• These surveys ask respondents directly about their WTP or WTA for environmental changes.
• Many studies show respondents report higher values for Willingness to accept (require compensation) than WTP, though economic theory suggests they should be similar.
• This discrepancy is attributed to factors like the endowment effect (people value what they already have more) and the presence or absence of substitutes.

Question 41

Biases in Contingent Valuation

Answer 41

The “warm glow effect” refers to a phenomenon in behavioral economics where individuals feel a sense of satisfaction, happiness, or moral approval from the act of giving or contributing to a cause, even if the tangible benefits of their contribution are not directly experienced or felt.

• misunderstanding the questions.
• This effect can lead to an overestimation of one’s willingness to pay (WTP) for certain goods, services, or public goods, particularly those related to social welfare, environmental improvements, or charitable donations.

Question 42

Alternative to contingent valuation - Choice Experiments

Answer 42

• Surveys present respondents with bundles of goods that have different attributes, including price.
• This approach helps determine Willingness to pay, by analyzing the choices between different bundles.
• Realistic Decision-Making: This method simulates real-world decision-making, where consumers often consider multiple factors before making a purchase.

Question 43

Passive-use values

Answer 43

Refer to the non-market benefits that people derive from a resource or environmental asset even if they do not directly use or interact with it

Nearly 95% of respondents believed in the importance of protecting National Parks, even if they did not visit them, highlighting significant passive-use and bequest values (values placed on preserving parks for future generations).

To reduce hypothetical bias, respondents were reminded to consider their budgets during the survey.

Question 44

Preference methods

Answer 44

Preference methods are techniques used to estimate the value people place on goods or services that aren’t traded in markets, such as clean air, beautiful landscapes, or health improvements. These methods aim to understand individuals’ preferences for different outcomes or conditions and assign a monetary value to things that don’t have a direct price.

Question 45

Travel-Cost Method

Answer 45

Estimates the value of recreational areas, like parks or lakes, by looking at how much people spend on travel to visit these places

Question 46

Revealed Preference Methods

Answer 46

These methods infer the value people place on non-market goods based on their actual behavior and spending. The idea is to look at the choices people make in real life to understand their preferences.

Estimates the value of recreational areas, like parks or lakes, by looking at how much people spend on travel to visit these places (travel cost method, one type of revealed preference methods).

Question 47

Stated Preference Methods

Answer 47

These methods involve asking people directly how much they value a non-market good through surveys or questionnaires. Respondents state their preferences for hypothetical scenarios, which helps estimate the value of certain goods or services.

Examples: Contingent Valuation: A survey-based method where people are asked how much they would be willing to pay for a specific environmental improvement or how much they would accept as compensation for tolerating a loss.
Choice Experiments: Participants choose between different hypothetical scenarios with varying attributes to reveal their preferences and trade-offs between different factors.

Question 48

Hedonic models

Answer 48

Hedonic models analyze how the prices of goods vary with changes in these characteristics. By examining market data, such as real estate prices, the model estimates the implicit price (or value) people place on each individual feature.
For instance, the model can estimate how much extra people are willing to pay for a house with an additional bedroom or a better view.

allow for the measurement of the
marginal willingness to pay for discrete changes in an
attribute!

hedonic property value is a specific application of hedonic models, focusing on real estate markets.

regression analysis

Question 49

Hedonic wage approach

Answer 49

The hedonic wage approach is an economic method used to estimate the value of non-market job characteristics by analyzing how they affect wages. It helps understand how different aspects of a job, such as risk, working conditions, or job location, influence the wage rate that employees require to accept certain positions. This approach essentially breaks down a worker’s wage into the value of different job characteristics.

particularly when those risks are environmental, like exposure to toxic substances.

Question 50

Benefit Transfer and Meta-Analysis

Answer 50

Due to the high costs of conducting original contingent valuation studies, benefit transfer methods allow researchers to estimate values for new sites or contexts using data from existing studies.

Value transfers: Directly transferring estimated values from one context to another.

Benefit function transfers: Using a pre-existing function that relates site characteristics to values and adjusting it for the new site.

Meta-analysis: A statistical method that aggregates estimates from multiple studies and analyzes them to derive more general findings.

Question 51

Issues with benefit transfer methods

Answer 51

Benefit transfer methods can produce significant errors, with studies reporting discrepancies as large as 1000% in some cases.

Question 52

Averting Expenditures

Answer 52

Another revealed preference method - where people spend money to avoid environmental damage.

• t.ex individuals might purchase bottled water in response to contaminated drinking water or install air purifiers due to poor air quality.
• The statement emphasizes that people generally won’t spend more to avoid or reduce pollution-related problems than the actual damages those problems would cause them (lower-bound estimate).
• argues that ignoring averting expenditures may underestimate the true damages from pollution.
• In the case of contaminated drinking water, while averting actions like buying alternative water sources reduce illness rates, the costs of those actions need to be included to accurately measure the damage caused by contamination.
• They also cause a disproportionate
  hardship on poor households that cannot
  afford such coping expenditures

Question 53

Challenges in non-market valuation

Answer 53

• Nonmarket valuation refers to methods, estimate economic value of goods and services, not traded in traditional markets, such as environmental resources like clean air, parks, and biodiversity. These resources do not have a market price, researchers must find alternative ways to assess value.
• Aggregation - process of combining individual values to arrive at a total value for a resource or service. In nonmarket valuation, researchers need to understand how to sum up the values that different people place on an environmental good or service.
• Willingness to pay for environmental resources can depend on their distance from it. Someone close to park willing to pay more to preserve it because they use it frequently and value its benefits
• Who should be included? only near community, farther away?

Question 54

Limitations in (non-market) Valuation Studies

Answer 54

• Many nonmarket valuation studies only capture a part of the total value of environmental goods or services.
• Valuation methods often focus on specific aspects of value (like recreational use) while neglecting others (like ecological or aesthetic value).
• Underestimating Value: Due to these challenges, nonmarket valuation studies might underestimate the total economic value of environmental resources. This can lead to insufficient funding for conservation efforts.
• Informed Decision-Making: Understanding these challenges is crucial for policymakers and researchers to ensure that valuation methods are robust and that the total value of environmental resources is adequately represented in benefit-cost analyses.

Question 54

The Argument Against Valuing Life

Answer 54

• Frank Ackerman and Lisa Heinzerling argue that it is immoral to use benefit-cost analysis when valuing human life.
• Their central claim is that life has absolute, intrinsic value and should not be subject to financial trade-offs.
• BCA can result in regulations that permit a certain level of pollution, as long as the overall benefits are deemed to outweigh the costs. For example, if a factory can operate more profitably by emitting a specific level of pollutants, and if the economic benefits are greater than the health costs from that pollution, BCA might justify allowing that pollution to continue. –> immoral –> prioritizing money over human health
• This practice can lead to a moral and ethical failure to recognize the inherent value of each individual’s life. They contend that reducing human health and life to numbers undermines the ethical obligation to protect all citizens equally, regardless of the economic costs involved.
• he concerns also touch on issues of equity and justice, as often marginalized or vulnerable communities bear a disproportionate burden of pollution and its health effects. BCA may overlook these inequalities in its calculations, thereby failing to account for the moral obligation to protect the most vulnerable.

Question 55

The Argument for Valuing Life

Answer 55

• Emphasizing the reality of scarcity in resources. Cropper argues that failing to consider the costs and benefits of lifesaving measures would be immoral because resources are finite and need to be allocated where they can produce the greatest good.
• while zero pollution may seem like an ideal goal, achieving it would involve prohibitively high costs, which would require diverting resources away from other critical societal needs, such as healthcare or education.
• BCA is a practical tool that helps policymakers make difficult but necessary trade-offs between protecting lives and managing the costs of doing so.
• For instance, people might choose to drive faster (increasing their risk of death) to save time, or decide how much to spend on health measures based on personal risk preferences.
• Ignoring such realities in policymaking, she suggests, would deprive people of the opportunity to make informed decisions about their own risk exposure and protection.

Question 56

The Value of a Statistical Life

Answer 56

• One of the key tools in BCA for valuing life is the Value of a Statistical Life (VSL), which measures how much individuals are willing to pay for small reductions in their risk of death.
• It doesn’t put a price on life itself, but rather on reducing the probability of death across a population. For instance, if a policy reduces a toxic exposure that would have otherwise caused 10 deaths per 1 million people to only 6.67 deaths, and the population is collectively willing to pay $5 million for this risk reduction, the VSL in this case would be about $1.5 million.
• Studies show that estimates of VSL vary widely based on factors such as methodology, region, age, and income. In the U.S., agencies typically use VSL values between $5 million and $8 million, while in lower-income countries, VSL estimates tend to be lower, reflecting differences in income elasticity of demand—the percentage change in consumption based on a change in income.