midterm 1 prep Flashcards
Benefit
A benefit is any increase in an individual’s utility or the collective welfare of a a society
cost
a cost is any decrease in an ind’s utility or collective welfare of a society
what is the economic value of a good
sum of benefits to economic agents and we assume that the value can be given a monetary measure (ie cardinal measure)
despite the issues associated with monetizing all values, why is it important to do so regardless?
it is easier to assess the benefits and costs associated with a certain action or project - serves as a foundation for objective assessment and formal decision analysis
Further, if there is anything where we are unwilling to put a monetary measure on, we can just treat it as a constraint and avoid making trade-offs regarding it
For market goods when quantity changes are small the observed Price can often (but not always) be taken as a measure of the Value of a good. what is the exception?
the exception here is if the volumes being discussed are large relative to the size of the market. -need to think about the shape of the demand curve
Decisions concerned with small values imply small changes in supply or demand, these are unlikely to have significant impacts on the equilibrium market price.
non-market goods have no observed price - cannot use the pricing mechanism to ascertain the value of these goods in conducting CBA - what are these mechanisms?
contingent valuation, hedonic valuation, travel cost method - these attempt to derive a simulated-demand curve for the good in question (ie what the demand curve would look like if there was a market for a good)
what is another name for the demand curve under contingent valuation?
marginal social value curve
stated preference model aka
contingent valuation: asking survey respondents to state their preference (asking consumers if they prefer A to B or B to A and then inferring the value they place on the good)
revealed preference model
there is an active market for the good - then we can actually observe the trade-off being made rather than having it be hypothetical.
ie we know exactly how many ppl value a PS4 more than 250 - just count how many people have purchased one at this or greater than this price
what are the three issues in contingent valuation
strategic bias, marginal utility and the reference position of the survey respondent, framing effects
option value
valuing something you don’‘t want to use now but might want to use later
existence value
valuing something you don’t and will never directly use
what valuation method uses existing markets to value individual attributes of a good?
hedonic valuation
what occurs when individuals with private information regarding risks they face choose whether to insure and how much to insure
adverse selection: ie high risk individuals over-insure (since their expected benefit > expected cost of insurance)
potential solutions to adverse selection
group insurance, conditional insurance rates based on observable indicators, compulsory insurance
moral hazard
having compulsory full insurance can affect individual behaviour and make them less risk averse - but it is important not to overlook the potential impacts of moral hazard (not to blow them up too big)
what is risk pooling
as the number of insured ind increase, aggregate risk actually falls if the probabilities of outcomes are independent of each other
aka the more people in the insurance pool, the more predictable the overall payout is
objective probabilities represent —–; subjective probabilities represent —- within diff domains of the algebra
risk; uncertainty
t/f: under objective uncertainty, we can assign a single probability to each possible outcome and the probabilities are al l add up to 100%
TRUE: there is a given quantification of how likely various outcomes are under objective uncertainty
exogenous variables
variables that are determined outside the model by the modeller and fed through the model
endogenous variables
variables that are determined within the model (and responds to the shocks of the model) - these are additional facts that must change in the counterfactual to accomodate the exogenously specified change
parameters
govern how endogenous variables should change - laws that are immutable to any potential future
both io and cge represent three core elements of the economy, which are
final demand, factor supply, and production functions
what is callibration
specifying a baseline from which economic change can be evaluated - abstract representation of the economy as it currently exists - taken from the input output tables
leontief multiplier
IO model based projection of how exogenous changes in the consumption of final goods affect the demand for intermediate goods and raw factors of production
___ models are basically just a bunch of multipliers (ratios) that relate the final demand to all of the initial inputs required to produce that final demand
IO model
TF the foundations of the CGE approach are actually way older than the IO model
True
IO model usage has shifted from — to —
used to assess the distribution of gross impacts but now have shifted to making claims about net impacts (but the form of the model still has not changed)
what is an intermediate demand for a good
good is sold for further production (part of the production function of the economy)
TF people prefer the stream of benefits that accrue earlier in project lifespan than later
TRUE we value current consumption more than future consumption
why do we care about present vs future consumption when doing a CBA
the costs and benefits we consider in a CBA will not usually occur all at once but will be spread over several years
— allows for a systematic comparison of costs and benefits that occur in diff time periods
discounting - diff from inflation adjustments
diff between inflation and discounting
inflation is a change in price over time but discount rates are how the value of the good depends on how long you wait to get it
what are the four ways to convert future payoffs into present values for cost benefit analysis
NPV, CBR, IRR, and terminal value
which valuation method compares the size of total discounted benefit relative to the total discounted cost of projects
CB ratio
which valuation method assumes a zero NPA and backout the discount rate that would deliver that NPV
Internal rate of return (IRR)
TF when a rate is chosen, all costs and benefits should be discounted at the same rate
TRUE any deviation from this concept involves a really good reason
veil of ignorance
putting yourself in a position where you don’t know where you willl be in society so that you don’t make decisions based on who you are
what criteria do we try to maximize for economy as a whole?
construct social welfare functions (which express welfare as a function of individual utilities)
What assumptions does the Rawlsian social welfare function make?
Veil of ignorance: we know all the values of utility but we don’t know which one e will have - people generally tend to be risk averse - so we choose a rule that max utility of the worst off person
TF doing make inconsistent assumptions within a potential future
True- no contradictions such as using any resource twice, can’t double count costs or benefits
Hold constant any uncertainties like inflation changes, demand fluctuations, input cost fluctuations
If we think an area of uncertainty is likely to affect the outcome of the CBA, we can do a ———- (recalculate CBA metric under diff assumptions to see if the result changes)
Sensitivity analysis
General cost benefit analysis principles
Need to become an expert (or have access to an expert) on the subject
Need to determine/define groups for which you are doing the analysis (May or may not be your client you are doing the CBA for)
You need to understand both the net benefit of doing the project and net benefit of status quo and not doing the project
6 initial steps in a CBA
- consider ref area/group and a time frame for consideration.
- initial cost and benefit identification
- think about ways to simplify the elements requiring assessment
- consider data you need to quantity cost and benefits for your data
- decide on the other (incidental) assumptions (inflation rate, timing of C and Bs, r)
- Use a spreadsheet analysis to find PV or other related CBA metric of the proposal or project
TF the ability to understand and conduct decision making process is more important than communicating the specifics.
F: equally important
describe the decision making context
decision choices could be choice of limited alternative options or a value from a continuous distribution.
continuous - optimization
discrete-optimization but also pairwise comparison
strategic interaction becomes relevant when
if there are multiple decision makers and outcomes are interdependent of each other - “game theory”
utility is a useful concept here in thinking about “a good defn of —-“
value but it is too abstract to practically quantify
the market demand function gives
total quantity demanded by consumers at any given price
quantity demanded
number of consumers with a reservation price at or above the actual price
total consumer surplus
diff between the demand curve (willingness to pay) and the price to consumers of the items for only those items actually exchanged
marginal benefit function
consumers willingness to pay depends on quantity they get (they might want more than 1 of something) -related to diminishing marginal utility
summation
aggregating the consumers’ willingness to pay to determine a single measure of consumer surplus for entire group
two types of summation
horizontal and non-rivalrous
horizontal summation
rivalrous good
vertical summation
non-rivalrous good
