Vocabulary

Question 1

What is the Natural Capital Model of Economic Production?

Answer 1

A model that demonstrates how economic systems are necessarily impacted by the natural environment and vice versa.

Question 2

Define environmental source.

Answer 2

Raw materials from the environment that are used as input for economic systems.

Question 3

Define environmental sink.

Answer 3

Waste generated as an output of economic systems that re-enters the environment.

Question 4

Describe benefit-cost analysis.

Answer 4

BCA is the comparison of the marginal benefits of an activity to the marginal costs incurred by that activity.

Question 5

Is the slope of MC positive or negative? Explain your answer.

Answer 5

MC is positively sloped due to the law of diminishing marginal returns. The marginal benefit received from each additional unit of input decreases, causing a subsequent increase in the marginal cost.

Question 6

Is the slope of MB positive or negative? Explain your answer.

Answer 6

MB is negatively sloped due to the law of diminishing marginal returns. The marginal benefit received from each additional unit of input decreases, causing a subsequent increase in the marginal cost.

Question 7

Define the Law of Diminishing Marginal Returns and state why it is important.

Answer 7

The LDMR states that if you increase the input of a factor of production, the marginal benefit you receive from each additional unit of input will begin to decrease. This is important because it determines the slope of the MB and MC functions, which are used in BCA.

Question 8

Define ecosystem services. List and describe the 4 primary categories of ecosystem services.

Answer 8

Various benefits provided by the natural environment that are necessary for human survival and wellbeing.
1. Provisioning services - products obtained from natural ecosystems (e.g. food, fuel)
2. Cultural services - non-material benefits that contribute to the wider needs and desires of a society (e.g. aesthetic values, tourism)
3. Regulating services - benefits obtained from the regulation of ecosystem processes (e.g. flood control, climate regulation)
4. Supporting services - necessary for the production of all other ecosystem services (e.g. photosynthesis, water cycling)

Question 9

Define Pareto efficiency and describe how it relates to markets.

Answer 9

Pareto efficiency occurs when net benefits are maximized, meaning one individual cannot have an increase in welfare without causing a decrease in welfare for another. Market-based capitalism is considered Pareto efficient.

Question 10

How is consumer surplus calculated?

Answer 10

1/2 x QD x (Pmax - PD)

Question 11

How is producer surplus calculated?

Answer 11

1/2 x QS x (PS - Pmin)

Question 12

How is total surplus calculated?

Answer 12

TS = CS + PS

Question 13

Define deadweight loss.

Answer 13

DWL is the lost welfare that could have been gained by society is resources were allocated efficiently.

Question 14

Define property rights. List and describe the 2 characteristics that property rights are a function of.

Answer 14

Property rights are rules or conditions that define ownership of goods, services, and resources; usually in the form of laws
Rival goods - when consumption of a good reduces its availability to others (e.g. food, clothing, cars)
Non-rival goods - when consumption of a good or service does NOT reduce its availability to others (e.g. clean air, public safety, street lights)
Excludable goods - when producers can exclude others from consuming a good, usually based on willingness of ability to pay (e.g. public transport, streaming subscriptions, personal electronics)
Non-excludable goods - when producers can NOT exclude others from consuming a good (e.g. environmental protection, radio broadcasts, knowledge)

Question 15

Using rivalry and excludability, define and provide examples for the 4 different types of goods.

Answer 15

Private goods - rival and excludable (e.g. cars, plane tickets, golf balls)
Common pool resources - rival and non-excludable (e.g. global fish populations, forests, groundwater)
Club goods - non-rival and excludable (e.g. toll roads, golf course, movie theaters)
Public goods - non-rival and non-excludable (e.g. environmental protection, national defense, public education

Question 16

Define a market failure.

Answer 16

occurs when the market is inefficient and does not generate maximum benefits

Question 17

Define an externality. List and describe the 4 types of externalities using the 2 dimensions along which they are distinguished.

Answer 17

Externality - a type of market failure that occurs when the production or consumption of a good or service generates a cost or benefit for a third party that is not directly related in the transaction
Negative consumer externality - when the consumption of a good negatively affects others that are not actively participating in the consumption of that good; corrected by shifting the demand schedule leftwards and reaching an equilibrium with decreased quantity and decreased price
Negative producer externality - when the production of a good negatively affects other that are not actively participating in the production of that good; corrected by shifting the supply schedule leftwards and reaching an equilibrium with decreased quantity and increased price
Positive consumer externality - when the consumption of a good positively affects others that are not actively participating in the consumption of that good; corrected by shifting the demand schedule rightwards and reaching an equilibrium with increased quantity and increased price
Positive producer externality - when the consumption of a good or service positively affects others that are not actively participating in the production of that good; corrected by shifting the supply schedule rightwards and reaching an equilibrium with increased quantity and decreased cost

Question 18

List and describe the 3 ways to address market failures.

Answer 18

Command-and-control regulations: make introducing social costs to the environment illegal, but are sensitive to non-target impacts
Pigouvian taxes and subsidies: direct intervention is able to adjust the market towards social optimum, but require perfect knowledge of social costs and benefits by the government that imposes them in order to be efficient
Coasian bargaining: requires no government intervention, but property rights must be clearly defined and there must be low transaction costs

Question 19

What is Coase theorem? Define Coasian bargaining and list its limitations. What principle is Coase theorem often used to endorse?

Answer 19

Coasian bargaining involves solving externalities by allowing the injured party to discuss and compromise about compensation with the injuring party without government intervention. Coase theorem states that in the event that property rights are clearly defined, and transaction costs are low, the efficient level of pollution will be achieved via bargaining. In the event of high transaction costs, there is an overstatement of marginal cost by the polluters to account for legal fees, causing an inefficient equilibrium. Coase theorem can be used to endorse the polluter-pays principle, which states any polluting party should pay for abatement, but this does not address transaction costs or non-excludability of environmental resources.

Question 20

Define the elasticity of demand. What is the midpoint formula for calculating the elasticity of demand? Is the slope positive or negative? Explain your answer. How does this relate to the use of Pigouvian taxes in environmental issues.

Answer 20

Elasticity is the degree to which demand responds to change in an economic factor. The elasticity of demand is always negative because the demand function has a negative slope. A good is inelastic when|ε| < 1. A good is elastic when |ε| > 1.

Question 21

How does the inelasticity of demand relate to the use of Pigouvian taxes in environmental issues.

Answer 21

Environmental goods such as food are highly inelastic due to no available substitutes, meaning there is a steeply sloped demand function. A Pigouvian tax shifts the supply schedule to the left, which causes a very small decrease in quantity and a significant increase in price.

Question 22

Explain the consequence of ignoring indirect and non-use values when conducting a BCA for environmental protection.

Answer 22

The calculated optimal outcome is inaccurate if indirect and non-use values are ignored because marginal benefits are understated, causing abatement to be lower. In other words, BCA will be mis-specified, leading to inefficient abatement.

Question 23

Define stated preference methods and provide an example. List the 3 approaches to this example.

Answer 23

Stated preference methods estimate willingness to pay for environmental protection via SELF-REPORTING in surveys. Contingent value method surveys are a kind of stated preference method that surveys an individual’s WTP for environmental protection. Survey responses are used to derive a hypothetical demand function for environmental protection even though that market does not exist. A payment vehicle is the exact way that WTP is reported depending on the phrasing of the survey question.
The voluntary donation approach asks respondents to provide a value of WTP for abatement. Free-riding is a type of market failure that occurs when individuals volunteer an understatement in their WTP because of the non-excludability of environmental protection.
The referendum approach states a price for environmental protection and asks respondents whether or not they are WTP. Yes/no format.
The menu price approach offers a list of different prices and allows respondents to choose, demonstrating a resilience to bias when compared to the voluntary donation approach with more detail than the referendum approach.

Question 24

Describe bias in the context of contingent value method surveys.

Answer 24

Bias occurs from self-reporting statements in CVM surveys.
Positive bias occurs when a value is understated.
Negative bias occurs when a value is overstated.
Strategic bias occurs when a respondent knowingly reports a stated WTP that differs from their true WTP for the purpose of an ulterior motive that influences the outcome of BCA.
Information bias occurs when a respondent’s WTP may be influenced by information presented on the CVM survey.
Hypothetic bias occurs when a respondent records nonsense answers because there is not feeling of commitment.
Payment-vehicle bias occurs when respondents provide nonsensical responses to the CVM survey as a protest to the wording of the survey question.

Question 25

Define revealed preference methods. List and describe 2 examples.

Answer 25

Revealed preference methods estimate WTP for environmental protection using EMPIRICAL DATA (observable) from related markets.
The travel cost method estimates indirect use values by measuring how much people pay to access natural environments.
Hedonic analysis estimates marginal WTP for access to environmental amenities using established markets, usually housing markets

Question 26

What market failure occurs when opportunity costs are not factored into environmental protection in BCA?

Answer 26

MC will be understated, causing the cost of abatement to be understated.

Question 27

Define positive and negative opportunity costs. Provide examples.

Answer 27

Positive opportunity costs involves giving up something valuable for environmental protection. Occurs as a result of scarcity forcing tradeoffs. (e.g. decreased GDP leads to job loss)
Negative opportunity costs occurs when resources are pulled from unproductive areas to support environmental protection and results in higher productivity, ultimately saving the firm money (e.g. creates green jobs, technological developments)

Question 28

What are the 2 sources of intemporal value consistency in dynamic BCA?

Answer 28

1. opportunity cost
2. natural rate of time preference

Question 29

Define present value. What equation is used to determine it?

Answer 29

Present value (PV) is the value of a future outcome translated into its present-day equivalent.
PV=FV/(1+r)^t
FV = future value
r = discount rate - as a decimal
(1 + r) = discount factor
t = number of time periods that must pass before FV may be realized

Question 30

What is the equation for the present value of net benefits?

Answer 30

PV(NB) = (TBt - TCt) / (1+r)^t

Question 31

Describe how static and dynamic benefit-cost analysis differ.

Answer 31

Static BCA maximizes NB by choosing abatement subject to MB=MC.
Dynamic BCA maximizes the PV of NB by finding the sum of discounted NB evaluated at each interval of time.

Question 32

Why are discount rates important when considering dynamic efficiency?

Answer 32

They are thought to include both sources of intemporal value consistency (opportunity cost and natural rate of time preference).
If the role of discounting is ignored in BCA, the benefits and the costs will both be overstated, leading to an inefficient outcome of abatement. Benefits are usually more overstated than costs in this scenario.

Question 33

What is the equation for expected value?

Answer 33

EV = ΣpiVi
EV = expected value
pi = probability of observing outcome i
vi = value associated with outcome i

Question 34

What is the equation for the expected value of the present value of net benefits? When is this value dynamically efficient?

Answer 34

When EVPVNB > 0, then the choice is dynamically efficient.