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

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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?

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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?

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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.

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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

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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

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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

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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.

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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

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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.

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

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

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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

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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

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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

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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

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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

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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

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http://en.wikipedia.org/wiki/The_Limits_to _Growth http://en.wikipedia.org/wiki/The_Limits_to _Growth Written in 1972, predicting over use of resources http://en.wikipedia.org/wiki/The_Populatio n_Bomb http://en.wikipedia.org/wiki/The_Populatio n_Bomb Written in 1968, predicting a population crash due to resource scarcity The wager : http://en.wikipedia.org/wiki/Simon%E2%80%93Eh rlich_wager

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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 = Hotellings Rule - net price rises over time with the rate of interest.

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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

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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

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