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AGEC/FNR 406 LECTURE 11

AGEC/FNR 406 LECTURE 11. Dynamic Efficiency. Two lectures required. Read pages 28-38 of Kahn. Static Efficiency Revisited. P. Static Efficiency is obtained when Net Benefit for one period is Maximized.

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AGEC/FNR 406 LECTURE 11

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  1. AGEC/FNR 406 LECTURE 11

  2. Dynamic Efficiency Two lectures required. Read pages 28-38 of Kahn.

  3. Static Efficiency Revisited P Static Efficiency is obtained when Net Benefit for one period is Maximized. Is triangle as large as possible? S=MC D=MB Q

  4. Static Efficiency Time is not a factor Demand can be satisfied via production (scarcity is not a problem) Equilibrium price reflects MB to consumers and MC to producers

  5. Horizontal Supply Curve Step one: demand curve P = 8 - 0.4Q P Step 2: supply curve MC =2, constant 8 Step 3: NB? Producer surplus = 0 Consumer surplus = 1/2 of (8-2)*15 = 45so NB = 0 + 45 = 45 2 20 15 Q

  6. Exhaustible Resource (e.g. coal) MEC = marginal extraction cost. Assume total available supply = 20 tons. Consumers willing to purchase 15 tons.NB = 45 P 8 2 20 15 Q

  7. What if the total supply of ore must be allocated over two periods? 1 2 P P Q Q

  8. Does this allocation maximize NPV of benefits? NB1 NB2 P P 5 15 Q Q Q

  9. Dynamic Efficiency Time is a factor, resource allocation is not independent across time. Criteria for efficiency is to maximize present value of net benefits Supply should be restricted in the current period to provide some stock for the future.

  10. What are net benefits? NB1 = 1/2 of 15*(8-2) = 45 NB2 = 0.5*(8-6)*5 + 5*(6-2) = 25 8 8 6 2 2 5 15 Q Q

  11. What is the NPV? NB1 = 0.5*15*(8-2) = 45 NB2 = 0.5*(8-6)*5 + 5*(6-2) = 25 Now compute NPV: NPV = NB1 /(1+r)0 + NB2 /(1+r)1 if r = 5%NPV = 45 + 25/1.05 = 45 + 23.8= 68.8

  12. Is a NPV of 68.8 the maximum that can be obtained with 20 units of ore, allocated over two periods? No!

  13. For example, what about an even allocation to each periods of 10 units? Step 1: find price NB= 0.5*(8-4)*10 + 10*(4-2) = 40 P= 8 - .4*Q 8 P= 8 - .4*10 = 4 4 Step 2: find NB1 and NB2 2 10 Q

  14. Step 3: find NPV NPV = NB1 + NB2 /(1+0.05)1 NPV = 40+ 40/1.05 = 40 + 38 = 78 > 68.8 8 8 4 4 2 2 10 10 Q Q

  15. Is an allocation of 10 + 10 the dynamically efficient allocation? No!To be continued…

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