 Homework #8 due  Group Outline due  Next Thursday Homework 9 Quiz 4

 Suppose a proposal is made to construct a new interstate highway through a plot of undisturbed land. Briefly summarize how you would use cost-benefit analysis to evaluate this proposal. What economic techniques would you use to assess some of the environmental impacts?

 What is the difference between willingness-to-pay and willingness-to- accept? Do the two measures tend to be similar when used to value the same good or service? Why is this a problem with economic valuation?

 Accounts for the time value of money  Rate at which a dollar value increases over time  Present Value – The value of money in the future, put in terms of the value of money today.

 For the i th period  PV [B i ] = B i /(1+r) i  For the sum across all period  PV [B] = ∑ i=1 n B i /(1+r) i

 The discount rate affects policies that have long term consequences.  For example, consider the construction of a dam.  3 years to build  50 years of operation  50+ years of environmental damage

 If r is set high The short run is favored.  Poor societies where struggle for today is impossible  Developed countries where the term of office for policymakers is short Benefits of dam will be stated as smaller But so will the cost environmental damage

 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.

 Neither a high or low discount rate is better for environmental valuation.  Low discount rates are often advocated on the needs of future interests Global Climate Change Soil Erosion

 OMB = rate of return on government bonds (1.6 to 3.5)  World Bank often uses 10  Sensitivity Analysis is an analytical tool that studies how the outputs of a model changes as the assumptions of the model changes.

 Risk – the probability that an event will happen  Uncertainty – different outcomes may occur  Consider a person who smokes

 EV [X] = p[X] C[X]  p is the probability of event X occurring  C is the cost of event X

 Risk aversion is the tendency to prefer certainty instead of risky outcomes, particularly in cases where actions may cause significant negative consequences  Precautionary principle is the view that policies should account for the uncertainty by taking steps to avoid damaging outcomes, especially when the outcomes are irreversible

 Physical supply - available reserves measured in physical terms without regard for cost and value  Economics supply – the amount of a resource that is available based on current prices and technology

 Identified reserves – the identified quantity of a resources; includes both economic and subeconomic reserves  Indicated or inferred – resources that have been identified but whose exact quantity is not known with certainty

 Hypothetical – the quantity of a resource not identified with certainty but hypothesized to exist  Speculative – the location and quantity of a resource has not been identified but is hypothesized to exist

 Subeconomic resources – resources whose costs of extraction are too high to make production worthwhile  Economic reserves – resources of high enough quality to be profitably produced and are identified

 Changes to reserves The resources is extracted and used => diminished reserves New resource deposits are discovered => increasing reserves Changing price and technology can make more or less of the known reserves economically viable

 _Growth _Growth Written in 1972, predicting over use of resources  n_Bomb n_Bomb Written in 1968, predicting a population crash due to resource scarcity The wager : rlich_wager

 R=P-MC  PV [R] = R 0 + R 1 /(1+r) + R 2 /(1+r) 2 +…  Optimal extraction quantity  R 0 = R 1 /(1+r) = R 2 /(1+r) 2 =…  Hotelling’s Rule - net price rises over time with the rate of interest.

 Technology Decreases marginal cost of extraction  Higher quality resources will be extracted first. => subeconomic resources may become economic when the price rises or technology improves

 Choke price – the minimum price of a good or service that would result in a zero quantity demanded  Price path – the price of a resource over time  Extraction path – the extraction rate of a resource over time

 Homework #8 due  Group Outline due  Next Thursday Homework 9 Quiz 4