Test 1 Flashcards
Get this money
Philosophically, what do we need to assume about income distribution in environmental econ?
We need to assume that income distribution is fixed and optimal, otherwise optimal environmental values will not be chosen
What is the best environment?
the environment most preferred by humans
How does scarcity relate to environmental goods?
Humans must decide what to produce, if we produce an environmental good other goods must be sacraficed
What makes a decision optimal?
Optimal decisions occur when the marginal cost of a good equals the marginal benefit
Ordinary Private good
Rivalrous and excludable, market quantities are optimal
Ex: food, clothes
common pool resources
Rivalrous and nonexcludable
market quantities are not optimal
Ex: fisheries, air, water
club goods
nonrivalrous and excludable
market optimal
ex: satellite tv or cinemas
pure public goods
- nonrivalrous and nonexcludable
- private markets wont produce these goods
- cannot be profitable
- efficient price charged is 0, huge positive externalities
ex: national defense, over air tv and radio
negative externality
- a negative, uncompensated effect of a transaction between two parties on a third party
- ie: social cost of buying cigs
- must be unintended
what are the two outcomes of coase theorem?
1) cost of polluter discontinuing is greater than cost of damages - compensate
2) cost of damages is more than cleanup - polluter discontinues
- both are efficient
what is the best way to characterize environmental problems?
- missing markets
- externalities occur because there is no market for scarce resources such as air or water
pigouvian taxation
- polluters should be charged the marginal damage of the pollution they cause
- creates the same economic incentives for environmental resources as ordinary inputs
cap and trade
- regulatory authority sells emission rights
- provides the same economic incentives as pigouvian tax
whats the problem with pigouvian and cap and trade?
monitoring capacity historically unfeasible
command and control approach
- dominant regulatory approach
- requires firms to use defined production methods
- requires households to use defined consumption methods
- more expensive than economic incentive approach
what do we define goods in terms of?
tons, not units
In a world lacking institutions to enforce efficient environmental policies…
households consume too much and firms produce too much
-environmental quality is nonoptimally low
how do households maximize utility?
households want to maximize utility from consuming…
- goods that emit residuals when consumed
- goods which dont emit residuals
- environmental quality
- occurs when you get the same bang per buck on all goods you consume
what does the marginal rate of substitution have to equal?
must equal price ratio
or, MUX/PX = MUXR/PXR
what is the utility function for households?
U(X, XR, E)
goods with no residual, goods with residual, environmental quality
how do firms maximize profits?
- by minimizing costs of labor/capital and material inputs
- firms will add inputs as long as it boosts total revenue more than it adds to cost
which way does the demand curve shift as a result of households failing to internalize externalities?
- demand curve shifts left/down
- too much quantity is demanded
which way does supply curve shift from not internalizing?
- shifts up and left
- produce too much quantity
takeaways from ch 2
- when uncontrolled, individual behavior gives rise to market quantities of polluting goods being exchanged that are too large
- nonoptimally large amounts of materials are produced and consumed and any nonrenewable resources are depleted too rapidly
what changes about X(residual) if optimal controls are inplace?
-if optimal controls are inplace, the “full price” of Xr goes up
what does a higher price of Xr imply?
- smaller amount of Xr will be purchased
- individuals will now consume the optimal amount of the pilluting good
- if firm behavior is also optimal, households will experience optimal level of E
What difference does optimal pollution control make for firms?
-material inputs will cost more because some of them lead to emission of residuals
what does the higher cost of material inputs imply?
- the firm buys smaller quantities of materials and residuals decrease
- firms increase their demand for nonmaterial inputs
- industry shrinks leading to even less residuals
graphically, what can be said about welfare lost or gained?
it points to the efficient outcome
in the absence of a regulatory institution, what happens to public goods as populations and incomes grow?
-pure public goods dissapear
what is necessary for new public goods to be created?
new public goods will not be provided without an instituion dedicated to their existence
when should a public good be provided?
-if the aggregate marginal benefit is greater than marginal provision costs
interest rates
- the price of consuming in this period rather than a later
- if the interest rate is 3%, consuming 100 now means you forgo 103 dollars of consumption next year
- provides the link between present and future periods
how are interest rates determined?
the loanable funds market
discounting and compounding
- discounting: $1 in the next time period is worth less than 1$ today
compounding: $1 this year is worth more than 1$ next year
what is the formula for a dollars value 2 years from now?
X= $1/(1+i)^2
what is the present value of an asset that pays 1 dollar a year?
- if the interest rate is 5%, its 20 dollars
- you could earn 1 dollar a year from 20 dollars
- this is a constant value asset
appreciating assets
- present value increases
- houses in growing areas
depreciating assets
- present day value decreases
- automobiles
How do you evaluate a project?
-we need to sum the present values of all its benefits and costs to find its net present value (NPV)
if the NPV is greater than 0…
the project should be adopted on efficiency grounds
if the NPV is less than 0…
- it will lower the value of our scare resources
- it returns less than alternate projects
- social welfare will be lower than it could be
- project is said to be inefficient
rules of evaluating projects
1) never accept a project unless its NPV>0
2) when budget is constrained, pick the subset of projects that maximizes NPV
3) among mutually exclusive projects, pick the maximum NPV
benefit-cost ratio
- (B/C)=(PVB/PVC)
- if the ratio is greater than 1 select the project, generally pick the highest
- dis-preferred to NPV
internal rate of return
- determines the discount rate which equates PVB and PVC or sets NPV = 0
- projects with a higher internal rate of return are said to be preferred
- as with cost benefit rations, this method can rank small projects with low costs to highly
benefits and costs
of a project are difficult to known
what three difficulties do policy makers face in determining what the pollution charge should be?
1) do households known their marginal benefit from an environmental good?(MB)
2) Do firms known how to react optimally to a charge on its residuals? (MC)
3) if both are yes will policy makers be able to extract and use this information
why is it difficult to known marginal damages from residuals?
- policy makers need to known the sum of the marginal willingness to pay of every household benefiting from an environmental policy
- it is unlikely any household can accurately quantify the damages from pollution or the gains from an environmental policy
zero-perception view
- households don’t known why they experience any number of healthy days
- analysts gauge the impact of the policy by measuring reductions in health outcomes
- assign a marginal value to increases in those outcomes and that reflects willingness to pay for damage reductions
perception perfect view
- households know what cause healthy days and engage in strategies to produce more
- an environmental policy can be seen as decreasing the cost of producing healthy days
real world perception
- some damages are perceived and others arent
- no clear solution on how to estimate damages when some are perceived and others aren’t
required add-on controls
ex: catalytic converters
- present value of these expected costs is calculated by adding up the discounted values of all resources employed as a result of the policy
required input or output substitutions
- cost incurred from substituting more expensive but less polluting input or output
- ex: requiring use of western coal which has less sulfur than eastern coal
policies of spatial or temporal relocations
- damages depend on how many people and things care about are present to be damaged
- geographical characteristics of the environment can mitigate or exacerbate pollution
- relocates pollution, does not address global issue
economic incentive approach
- now that we can measure emissions easily, we can use economic incentives to clean up the environment
- encourages those who are best at fighting pollution to do so
- cap and trade is most common approach
additional benefits to the economic incentive approach
- environmental quality is less expensive, so people will demand more environmental improvements
- households could buy polluting rights and no exercise them, if the cap was viewed as too large
- encourages economic growth without environmental degradation
- cap and trade may be preferred to a pollution tax because the environmental outcome is certain
