Valuation of non-marketed goods

1. Valuation of non-marketed goods

2. Non-marketed goods • Externalities and public goods complicate the estimation of impacts • Ignoring these will result in • Excluding (referent groups that are pertinent) • Under (overstating) benefits and costs • The challenge is to measure changes utility • Method 1 – experiments and measures of net impact • Method 2 – revealed preference • Method 4 – state preference

3. Walkerton • “In May 2000, bacteria seeped into Walkerton's town well. The deadly E. coli then slipped quietly through a maze of pipes and into the homes of Walkerton, Ont. Unsuspecting residents thirstily drank the polluted water and bathed in their bacteria-ridden tubs. But soon after, they began experiencing common symptoms of infection; bloody diarrhea and throbbing cramps. Seven people would eventually die and another 1286 would fall ill. The investigation which followed exposed an alarmingly unstable waterworks system made fragile by government cuts.” • http://www.cbc.ca/archives/categories/environment/pollution/death-on-tap-the-poisoning-of-walkerton/town-epidemic.html

4. Economic valuation of non-marketed goods • Consider the economic evaluation of regulations to adjust the way farmers manage manure and • A program to offer technical advice to famers to change practice and financial assistance (grants) to invest in manure handling equipment. • External effects comprise • Smell and pollution to all land users • Pollution for non-agricultural water users • Reduction in economic welfare of farmers that may be offset by exurban development that bids up the value of land • How should we value this? who should pay? What does a benefit cost analysis say about regulation and proscribes how manure is managed

5. Externalities • External cost (negative externality) • A cost that arises from an activity undertaken by an individual, firm or other economic agent and that is borne by others because the cost is not incorporated in the market price the agent pays. • External benefit (positive externality) • A benefit received by others that arises from an activity undertaken by an individual, firm or other economic agent for which the agent is not compensated in the market price paid for the good or service provided. • An externality is an impact (cost/benefit) on others arising from production or consumptions , which is not reflected in prices. Private costs and social costs diverge LO1: External Costs and Benefits and Their Affects on Resource Allocation

6. Externalities Distort the Allocation of Resources • Does the honeybee keeper face the right incentives? (Part 1) • When the bee-keeper has more hives, the bees pollinate the trees in the orchard more thoroughly, increasing the yield. • Positive externality. • Does the honeybee keeper face the right incentives? (Part 2) • When the bee-keeper has more hives, the more students and nursing home residents will be stung by bees. • Negative externality. LO1: External Costs and Benefits and Their Affects on Resource Allocation

7. Externalities and Resource Allocation Individuals considering only their own costs and benefits will tend to engage in…. • Too much in activities that generate negative externalities. • Market Price overestimates the benefits of the activity. • Prices do not include social costs • Too little in activities that generate positive externalities. • Market Price underestimates the benefits of the activity. • Price does not include the benefits LO1: External Costs and Benefits and Their Affects on Resource Allocation

8. FIGURE 10.1: How External Costs and Benefits Affect Resource Allocation Social MC = Private MC + XC The market equilibrium level of output (Qpvt) is larger than the socially optimal level (Qsoc) for products accompanied by external costs [panel (a)] but smaller than the socially optimal level for products accompanied by external benefits [panel (b)]. Social demand = Private demand + XB S XB Private MC MC XC Private demand D Qsoc Qpvt Qpvt Qsoc LO1: External Costs and Benefits and Their Affects on Resource Allocation

9. Coase theorem • The Coase theorem states that it is not necessary to assign liability or regulate pollution • Provided that • transactions costs (the costs of negotiation) are not too high, socially efficient equilibrium can be achieved regardless how the property rights are assigned. • It does not matter whether the chemical factory has the right to pollute or the salmon fishery has the right to water that is not polluted. • The Coase theorem fails to work because one party believes they should not need to negotiate and when the transactions costs exceed the benefit either parties could obtain by negotiation. “Coase makes the point that which ever way the law interprets the property rights, as long as these rights are well defined and the transactions costs of enforcing and transferring them are not too great, society's resources will be used most efficiently by just letting private agents work out these problems to their own mutual benefit.” http://faculty.wcas.northwestern.edu/~mwitte/pf/handouts/coase.html

10. Coase Theorem Example • “Consider a railroad that passes through wheat fields. The passing trains let off sparks which can burn the wheat. If the legal rights are on the side of the farmers, then they could require the trains to buy and install spark catchers to eliminate these fires. However, if that is expensive (i.e. more than the value of the burned wheat), the train owners may just pay the farmers for the damage done to the crops. If the legal rights are with the trains, the farmers may just put up with burned crops or (if that is expensive) they could pay the trains to put on spark catchers. Either way, the socially efficient outcome (install spark catchers or burn crops) is what happens and the legal rights just determine who has to pay.”

11. C:\Users\gmason.PRAINC\Documents\Pavtube\youtube_converter\Negative Externalities and the Coase Theorem - YouTube.mp4

12. Legal Remedies for Externalities • Costless negotiation and full information are very strong assumptions. • Negotiation is not always practical because: • Many potential participants. • Contracts can be difficult / costly to enforce. • Strategic behavior / bluffing . • In practice, many laws and regulations try to solve externality problems. • The burden of adjustment is often assigned to those who can adjust at the lowest cost or who have the fewest resources to object. Lo2: Policies to Offset Externalities

13. Optimal Amount of Externalities • The optimal amount of negative externalities is not necessarily zero. • Eliminating pollution has both benefits and also costs • The best policy will eliminate pollution until the cost of further abatement equals the benefit of further abatement. • The cleanup effort should be expanded only until the marginal benefit equals the marginal cost. Lo3: Optimal Externality is not Zero

14. Property Rights and the Tragedy of the Commons

15. Property Rights • People who grow up in the industrialized nations tend to take the institution of private property for granted. • Property rights are much more complex than simple possession. • The idea is much broader than land or housing (termed real property or real estate) Slavery is the expropriation of the individual’s right to sell his/her labour • The extent of property rights has, moreover, changed substantially over time in advanced industrial countries. • There are many unpriced resources that nobody owns. LO4: Tragedy of the Commons and Remedies

16. Tragedy of the Commons • The tendency for a resource that has no price to be used until its marginal benefit falls to zero. • One person’s use of commonly held property imposes an external cost on others, reducing the property’s value. • One solution: private ownership of the entire resource. • Single private owner will “internalize the externality”. LO4: Tragedy of the Commons and Remedies

17. When Private Ownership is Impractical • Defining private ownership rights does not always solve the tragedy of the commons. • Why are blackberries in public parks picked too soon? • Why does London, England, impose a tax on every vehicle that enters the central business district during business hours? • Enforcement of property rights may not be feasible. • Harvesting whales in international waters. • Controlling multinational environmental pollution. LO4: Tragedy of the Commons and Remedies

18. Rehabilitating the Green Tax • Some studies show that redistributing the surplus as an eco-bonus creates a progressive tax. • Green taxes at the retail level are regressive, but imposed at the upstream are less so it affects all incomes – salaries, rents, profits, dividends, which tend to fall more of richer households. • Green taxes should form part of a broader tax reform. For example a general shift to wealth taxes and a move to value added taxes (GST) and away from income taxes. Caution: Progressivity in taxation is not the only goal. Other goals must be sustainability (resource allocation is not disturbed to erode the tax base), ease of administration, and enforcement.

19. Area a Total costs minimized (area a + b) Area b Gov’t imposes a tax Total Abatement costs = Area under the MAC = ½ (200 x 50) = $1500 The basic math rests on geometry and the area defined by the rectangle that shows the marginal abatement cost/tax and emission level Allowing emissions costs nothing E0 = 50 MAC = marginal abatement cost

20. Technology lowers the MAC Cost of tax + abatement creates an incentive to invest in new technology With a tax of $100/tonne Industry 1: total cost = a+b+c+d+e Industry 3: total cost = b+d+e If the difference is technology, the gain is area a+ c

21. A tax imposed on industry will cost differentially depending on abatement costs of each firm (H and L) Total abatement is 80 + 20 Kg/mo An emission tax may have a lower social compliance cost than a uniform standard When abatements costs vary, a tax may be more cost-effective ($/kg controlled)

22. Optimal Green Tax: MAC = MD Total cost of damages foregone = e + f (total cost of abatement + avoided losses to the pollutee) The net benefit is f MD = marginal social cost of damages Total tax paid by the polluter is a+b+c+d, plus the abatement cost (e). Taxes are more costly to the firm than standard Cost of a standard (set at E*) is just e. Why tax? What dangers exist in using a tax

23. What is the least costly way to cut pollution by half? Note – different way to show MAC • If tax is $40/tonnes, Sludge Oil would continue to use process A and Northwest Lumber, would switch to process B, cut pollution by 1 tonnes only. • If tax is $101/tonnes, Sludge Oil would now switch to process B and Northwest Lumber, would switch to process D, cut pollution by 4 tonnes. • The total cost of the reduction would be only $280/day ($100/day for Sludge Oil and $180/day for Northwest Lumber), which is less than previously. • The firm’s marginal benefit from any activity that reduces its pollution by one more tonne is exactly the amount of the tax (MB = MC). MB = MC Lo2: Policies to Offset Externalities

24. What will be the price of pollution permits? • Suppose the government could give two permits free of charge to each firm, allowing them to then sell or purchase permits. • If Sludge Oil uses the permits, it will produce at point c, with the MAC at $400/day. If a permit on sale for $300, it is profitable for Sludge oil to buy it and produce at b. • If Northwest Lumber uses the permits, it will produce at point C, with the MAC at $100/day. If it can sell a permit for $300, it is profitable for Northwest Lumber to sell it and produce at D. • It has the same result as a tax method. Lo2: Policies to Offset Externalities