Presentation on theme: "Upcoming in Class Homework #5 Due Today Homework #6 Due Oct. 25"— Presentation transcript:
1Upcoming in Class Homework #5 Due Today Homework #6 Due Oct. 25 Quiz #3 Oct. 27thWriting Assignment Due Oct. 27thExam #3 Thursday Nov. 3rd
2HW #5Suppose a market demand schedule for a resource is P = Q and the market supply schedule is P = Q.What is the equation for the marginal net benefit curve?Disregarding future time periods, how much of the resource would be produced?What is the marginal net benefit at this level of production?
3HW #5 What is Hotelling’s rule? Include an explanation of how a change in the interest rate will affect the price of a resource over time.
5Chapter 5 - A Two-Period Model AssumptionsFixed supply of oilConsider two time periods onlyTotal supply is 20 tonsDemand (marginal WTP) is constant:Calculate NB = P – MC = 6 – 0.4 Q
6Chapter 5 - ProblemAssume the demand conditions are the same, but let the discounted rate be 0 and the marginal cost of extraction be $4. Total supply available = 20. How much would be produced in each period in an efficient allocation?What would be the marginal user cost in each period?Would the static and dynamic efficiency criteria yield the same answers for this problem? Why?Efficient allocation is 10 and 10. the static and dynamic models are the same. User cost = 0
7Chapter 5 - ProblemAssume the demand conditions are the same, but let the discounted rate be 0 and the marginal cost of extraction be $4. Total supply available = 10. How much would be produced in each period in an efficient allocation?What would be the marginal user cost in each period?Would the static and dynamic efficiency criteria yield the same answers for this problem? Why?Efficient allocation is 5 and 5. the static and dynamic models are not the same. User cost = $2
8Marginal User CostThe opportunity cost caused by intertemporal scarcity is called the marginal user cost (MUC).The marginal user cost for each period in an efficient market is the difference between the price and the marginal extraction cost.
9Change in discount rate A higher discount rate will favor the present. The amount allocated to the second period falls as the discount rate rises.
10Discount RateThe annual rate at which future benefits or costs are discounted relative to current benefits or costs.PV = NB2/(1+r)n
11Chapter 5 - ProblemsAssume the demand conditions are the same, but let the discounted rate be 0.10 and the marginal cost of extraction be $4. Total supply available = 20. How much would be produced in each period in an efficient allocation?Assume the discount rate is What happens to the efficient allocation?Assume the discount rate is What happens to the efficient allocation?R= qR= qR= qR= q
12Discount Rate and Marginal User Cost A higher discount rate will favor the present. The amount allocated to the second period falls as the discount rate rises.Marginal user cost rises over time at the rate of discount causing efficient prices to rise over time and thus reflecting scarcity.Scarcity rent is producer surplus that exists in the long run due to the fixed supply of resources.
13The Efficient Market Allocation of a Depletable Resource: The Constant-Marginal-Cost Case. (a) Period 1 (b) Period 2
14Efficient Intertemporal Allocations The Two-Period Model RevisitedDynamic efficiency is the primary criterion when allocating resources over time.An n-period model presented uses the same numerical example as before, but extends the time horizon and increases the recoverable supply from 20 to 40.
15The N-Period Constant-Cost Case With constant marginal extraction cost, total marginal cost (or the sum of marginal extraction costs and marginal user cost) will rise over time.The graph shows total marginal cost and marginal extraction cost.The vertical distance between the two equals the marginal user cost. The horizontal axis measure time.Rising marginal user cost reflects increasing scarcity and the intertemporal opportunity cost of current consumption on future consumption.
16FIGURE 7.2 (a) Constant Marginal Extraction Cost with No Substitute Resource: Quantity Profile. (b) Constant Marginal Extraction Cost with No Substitute Resource: Marginal Cost Profile
17Chapter 6 – Discount Rate Accounts for the time value of moneyRate at which a dollar value increases over timePresent Value – The value of money in the future, put in terms of the value of money today.
18Present Value of $1,000 at Different Discount Rates
19Discounting For the ith period PV [Bi] = Bi/(1+r)i For the sum across all periodPV [B] = ∑i=1n Bi/(1+r)i
20Discounting & Environmental Policies The discount rate affects policies that have long term consequences.For example, consider the construction of a dam.3 years to build50 years of operation50+ years of environmental damage
22Discount Rate If r is set high The short run is favored. Poor societies where struggle for today is impossibleDeveloped countries where the term of office for policymakers is shortBenefits of dam will be stated as smallerBut so will the cost environmental damageFor example, imagine the construction of a nuclear power plant. We benefit from that plant for 40 years, but the environmental damage from hazardous wastes sticks around for hundreds of years. So a high discount rate is going to severely discount the cost of environmental damage in future periods.
23Discount Rate If r is set low Weights long term environmental damage heavier.If the damages extend beyond the life of the project, then it is likely that the project will be canceled.
24Discount Rate and Policy Neither a high or low discount rate is better for environmental valuation.Low discount rates are often advocated on the needs of future interestsGlobal Climate ChangeSoil Erosion
25Discount Rates Utilized OMB = rate of return on government bonds (1.6 to 3.5)World Bank often uses 10Sensitivity Analysis is an analytical tool that studies how the outputs of a model changes as the assumptions of the model changes.Assumption that changes is the discount rate. At what rate does the discount rate have to be for the policy to have a net benefit? At what rate does the discount rate have to be for the policy to have a net loss?
26Future Outcomes Risk – the probability that an event will happen Uncertainty – different outcomes may occurConsider a person who smokes
27Expected Values EV [X] = p[X] C[X] p is the probability of event X occurringC is the cost of event X
28Expected ValuesRisk aversion is the tendency to prefer certainty instead of risky outcomes, particularly in cases where actions may cause significant negative consequencesPrecautionary principle is the view that policies should account for the uncertainty by taking steps to avoid damaging outcomes, especially when the outcomes are irreversible
29Chapter 12 – Non-renewable Resources Physical supply - available reserves measured in physical terms without regard for cost and valueEconomics supply – the amount of a resource that is available based on current prices and technology
31ReservesIdentified reserves – the identified quantity of a resources; includes both economic and subeconomic reservesIndicated or inferred – resources that have been identified but whose exact quantity is not known with certainty
32Undiscovered Reserves Hypothetical – the quantity of a resource not identified with certainty but hypothesized to existSpeculative – the location and quantity of a resource has not been identified but is hypothesized to exist
33Resource lifetimeSubeconomic resources – resources whose costs of extraction are too high to make production worthwhileEconomic reserves – resources of high enough quality to be profitably produced and are identified
34Resources Changes to reserves The resources is extracted and used => diminished reservesNew resource deposits are discovered => increasing reservesChanging price and technology can make more or less of the known reserves economically viable
35“Limits to Growth” http://en.wikipedia.org/wiki/The_Limits_to_Growth Written in 1972, predicting over use of resourcesWritten in 1968, predicting a population crash due to resource scarcityThe wager : rlich_wager
39Marginal Cost of Extraction Technology Decreases marginal cost of extractionHigher quality resources will be extracted first. => subeconomic resources may become economic when the price rises or technology improves
41Resource ExtractionChoke price – the minimum price of a good or service that would result in a zero quantity demandedPrice path – the price of a resource over timeExtraction path – the extraction rate of a resource over time
42Change in World Reserve Base for Selected Minerals