Final Deck Flashcards
Define Economic Value
*Must be valued either directly or indirectly by humans *Measured in terms of tradeoffs - what is the maximum one would be willing to give up (willingness-to-pay) in terms of – money; time; other goods *
Why Is The Supply Curve Upward Sloping?
*Costs money to produce something new, so as you create new things its going to increase the amount your spending
Under Competitive Market Conditions, The Producer Gets One Price For All Units of Production
TOTAL REVENUE
TOTAL REVENUE = PRICE * QUANTITY
The Total Cost of Production
The Producer Surplus
PROFIT
Consumer Surplus
Consumer Surplus = Total Willingness To Pay - Cost
Total WTP
Add Up the Marginal Willingness-To- Pay = Total WTP
Total Cost
Add up the Marginal Costs to Consumers = Total Cost
Consumer Surplus
Consumer Surplus = Total WTP-Cost
How Do We Know This Market Outcome is Best = Highest Value to Society?
Pareto Efficient
*An economic outcome is Pareto Efficient if there is no way to make any person better off without hurting anybody else.
*The competitive market determines a Pareto efficient amount of output because at Q* the price that someone is willing to pay to buy an extra unit of the good is equal to the price somebody must be paid to sell an extra unit of the good.
Example: calculating Producer Surplus
• Base of the triangle = $20-$2 = $18
- Height of the triangle = 100
- Area = 1⁄2 base X height
- Producer Surplus = $900
Taking Into Account the Cost of the Externality on the demand and cost of a product
Taking Into Account the Cost of the Externality Shifts the Supply Curve Up
Example: Whats the change in producer surplus taking into account the externality shift?
Find the area of the new triangle and subtract the bigger triangle from the smaller triangle. Youll usually end up with a negative number.
• New Producer Surplus:
– New Base =$24-$3.20 = $20.80
– New Height = 80 bushels
– Note less produced at a higher cost – New PS = $832
• Change in PS = $832-$900 = -$68
Whats the change in consumer surplus taking into account the extrnality factor?
Results of externality factors
Including some of the harm from the pollution externality into the market resulted in:
– Less being produced
– At a higher price
– Consumers are clearly always worse off
– Producers are usually worse off unless price goes up a real lot.
Need to know: Economic Definition of Value
– Willingness-to-Pay
– Producer and Consumer Surplus
• Calculate using simple geometry (1⁄2 b X h) • Calculate CHANGE in value
Need to know: Economic definition of externality
DEFINITION OF ‘EXTERNALITY’
A consequence of an economic activity that is experienced by unrelated third parties. An externality can be either positive or negative.
Pareto improvement:
A change in conditions (policy, allocation of resources, etc.) that leaves some individuals or groups better off and all other individual or groups at least as well off as they were before the change
Pareto efficient (Free market outcome w/o externalities):
– No additional change can be made that is a Pareto
improvement.
– Example (the sale of a used car): The seller value the car at $15,000, while the buyer is willing to pay $20,000 for it. A deal in which the car is sold for $17,500 would be Pareto improvement since both the seller and the buyer are better off as a result of the trade.
Policy Outcomes
Pareto improvements are win-win situations.
However, most policy changes create some winners and some losers.
Even a market exchange will not be a Pareto improvement in there are external costs (i.e. pollution).
Thus, the Pareto criterion usually can’t tell us whether one policy is “better” than another.
We need another way to compare outcomes. (Kaldor Hicks)
(Kaldor-Hicks) Compensation Principle:
Some groups (individuals) are made worse off (losers) and some are made better off (winners). But the amount that the winners gain is more than the amount the losers lose. The winners could compensate the losers.
– The decision on whether or not to actually use gains to compensate the losers is a political decision, not an economic decision.
Policy Outcomes: example
- Under policy X: Waterman A is allowed to catch 10 bushels of crabs, waterman B is allowed to catch 100 bushels of crabs.
- Under policy Y: Waterman A is allowed to catch 20 bushels of crabs, waterman B is allowed to catch 99 bushels of crabs.
- The adoption of policy Y would not be Pareto improvement, since waterman B is now worse off.
- It would be a Kaldor–Hicks improvement, as waterman A could give waterman B anywhere between 1 and 10 bushels to accept this alternative situation.
Is every Pareto improvement is a Kaldor–Hicks improvement?
Yes
True or False: Most Kaldor–Hicks improvements are [actual] Pareto improvements.
FALSE
Kaldor-Hicks efficiency
*Under KH criterion a more efficient outcome can in fact leave some people worse off.
*Kaldor-Hicks efficiency is a less stringent criterion and more applicable in the real world.
*KH underlies the idea of cost-benefit analysis.
What Level of Restoration Is Best?
Cost-Benefit Analysis
True or False: Fish are a Renewable Resource
Fish Stock
Fish Stock – the amount of fish by weight or
number
– replaces itself
– Smaller fish get bigger
– Reproduction
Rate of Replacement
depends on the stock size (weight or numbers of fish) at a given time
Why are fish renewable?
energy is being added to the system:
solar energy –> algae —> fish
What is the Relationship Between the Amount of Fish in the Bay and The Rate at Which It Replaces Itself?
Carrying Capacity
On average, the maximum amount of a species that can be supported on a continuing basis under current ecosystem conditions (habitat, food, predators)
Sustainable Harvest
*Harvest only the amount that the fish stock was growing that year will keep the fish stock at the same level, year after year
*Harvesting less than the annual growth allows the fish stock to get bigger in the next period
*Harvesting more than the annual growth makes the fish stock smaller in the next period
*Harvesting exactly the amount of annual growth keeps the fish stock at the same level
year after year (sustainable)
Maximum Sustainable Yield (MSY)
the largest harvest yeild that can be taken from a stock (of fish) so that the fish stock remains at the same level year after year
The Open-Access Fishery
The fishery is capable of producing positive economic rent.
However, under open-access , the resource produces zero rentbecause excessive level of fishing effort is being utilized:
– If E
– If E>EOA total costs of fishing would exceed the total revenues, some fishermen would lose money and withdraw from the fishery, reducing the level of effort E.
Resource rent
the difference between the price of the resource (marginal value) and the cost to harvest (marginal cost)
The Strange Case of the Fishery Supply Curve
Regular supply curve slopes upward, the more produced the greater the cost of production for the next unit (increasing marginal costs)
– More inputs used = greater cost = more produced
• But there is a maximum level of production (MSY)
• What happens beyond the maximum – Costs keep going up
– Harvest (production) starts going down
Open Access fishery is not an efficient solution
Open-Access leads to an Inefficient Solution: The same amount of fish could be caught at a much lower cost
Evolution of Fisheries Management
- Initially many fisheries around the globe characterized by open-access.
- Dissipation of rents led to the adoption of limited-access (i.e. # of participants is limited by the need of acquiring a license).
- Control of aggregate harvest under limited-access based on input-controls (i.e. restriction on hours and days allowed to fish, type of gear, etc.)
- Output-controls (i.e. limit in the total harvest by setting a TAC) better way to prevent overfishing than input controls.
TAC vs ITQs
* Initially, many regulators adopted output-controls (i.e. TACs).
* However, a TAC that is not allocated leads to derby- fishing (i.e. incentives for fishermen to invest in larger boats to outcompete other fishermen). The result is: shorter seasons, fishing under risky weather conditions, and lower prices due to market gluts.
* How to overcome this situation? Individual transferable Quotas (ITQs).
*Remember, however, that ITQs are controversial because of the initial allocation to individuals (case of MD striped bass discussed by Mike Luisi).
Experiment: On permit trading
TAC = 25 lbs
Market price = 7$
Total Revenue = 175$
Total Cost = 117$
Total Profit = 175$-117$ = 58$
If there are no restrictions on the holding of quota of fisherman, who ends up with the quota?
Fisherman 4 b/c he has the lowest cost.
Expirement 2 on Trading permits (15lb qouta for each fisherman)
• If there is a restriction of 15 lb. on the holding of quota of each fisherman, who ends up with the quota?
15lb will go to the fisherman with the cheapest cost and then the rest to the second cheapest
• What is the total cost of harvesting the entire TAC in this last scenario? = 85$
New Profit = 175$ - 85$ = 90$
Reduction in profit = 90-100 = -10$
