Valuing the Environment: Economic Concepts & Policies

1. Chapter 2Valuing the Environment: Concepts Environmental Economics and Policy Sixth Edition By Tom Tietenberg and Lynne Lewis

2. FIGURE 2.1 The Economic System and the Environment

3. Environment as Asset? • Note anthropocentrism • Implies humans have only significant perspective

4. Philosopher Arne Naess • “deep ecology” or “ecosophy” • Nonhuman environment has “intrinsic” value, not just “instrumental” value to people • Humans valuing the rest of the world has no more moral basis than the reverse

5. Benefit-cost (or cost-benefit) analysis, BCA (or CBA) • Note normative judgement • If the benefits exceed the costs, then the action should be supported • B > C means action is recommended • B/C > 1 means action is recommended

6. Benefits • derived from the demand curve for the good or service. • Total benefits (B) = total willingness to pay (WTP) = area under D curve • marginal benefits (MB) = marginal willingness to pay = price associated with that quantity on D curve.

7. FIGURE 2.2 The Individual Demand Curve

8. FIGURE 2.3 The Relationship of Demand to Willingness to Pay

9. Costs • derived from the marginal cost (supply) curve for the good or service • Total costs = area under MC (Marginal Cost) curve • Marginal opportunity cost is the cost of producing the last unit = point on MC curve associated with that Q.

10. FIGURE 2.4 The Relationship of Marginal Cost and Total Cost

11. Net benefit • the excess of benefits over costs • the area under the demand curve that lies above the supply curve • consumer plus producer surplus

12. FIGURE 2.5 The Derivation of Net Benefits

13. Issues with a time dimension • Present valueis a method for evaluating benefits and costs occurring at different points in time • Allows us to compare dollars today to dollars in some future period by translating everything back to its current worth. Then apply benefit-cost analysis.

14. Discounting & NPV • Discounting is the process of calculating present value. • The net present value of net benefits, NB, received n years from now is NPV = NB n / (1 + r ) n where r is the discount rate (e.g. a rate of 3% would be entered as 0.03).

15. Stream of Net Benefits • The net present value of a stream of net benefits {NB0, . . . , NBn} received over a period of n years is: NPV {NB0, . . . , NBn} = Σi = 0 to n, NB i/ (1 + r ) i.

16. TABLE 2.1 Demonstrating Present Value Calculations

17. Interpretation • Put PV in bank today • Earn r rate of interest • Withdraw payments each year = annual amounts • Balance at end of all n years will be 0

18. TABLE 2.2 Interpreting Present Value Calculations

19. Optimal outcome • One approach: Pareto efficient/optimalallocation, e.g., no other feasible allocation that would benefit one or more without negative effect on other(s) • Initial distribution is given; favors status quo • Equimarginalprinciple says that net benefits are maximized when MC = MB (or MWP)

20. FIGURE 2.6 Finding the Efficient Outcome

21. Example • MWP (MB) = $80 – 2q (Inverse D) • MC = $10 (Supply) • MC = MWP $10 = $80 – 2q Solve for q: 2q = 70; q = 35, P = $10 Where MWP = Marginal Willingness to Pay MB = Marginal Benefit MC = Marginal Cost

22. Static v Dynamic Efficiency • Allocation has achieved static efficiency if the net benefit from the use of those resources is maximized. • Allocation has achieved dynamic efficiency if it maximizes the present value of net benefits from all time periods.