Lecture 17 March

7/30/2019 Lecture 17 March

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1

Public Goods, Externalities andResources Valuation


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Public Goods are goods for which

exclusion is impossible. One example is National Defense: A

military that defends one citizen

from invasion does so for the entire

public.

Public Goods


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Characteristics of Public Goods Nonexclusion: The inability of a seller to

prevent people from consuming a good if

they do not pay for it.

Nonrivalry: The characteristic that if one

person consumes a good, another personspleasure is not diminished, nor is another

person prevented from consuming it.


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Externalities Externalities are costs or benefits of

market transactions not reflected in

prices.

Negative externalities are costs to third

parties.

Positive externalities are benefits to thirdparties .


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Externalities and Efficiency

The marginal external cost is the

dollar value of the cost to third

parties from the production orconsumption of an additional unit

of a good. These occur when

market transactions for a goodproduce negative externalities.


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Positive externalities The marginal external benefit is

the dollar value of the benefit tothird parties from an additional unit

of production or consumption of a

good. These occur when themarket for a good creates positive

externalities.


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Internalization of Externalities

An externality can be

internalized under policiesthat force market

participants to account for

the costs of benefits of their

actions.


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Property Rights and Internalization

of Externalities

Externalities arise because some resource

users property rights are not considered in

the marketplace by buyers or sellers of

products.

Governments can give businesses the right

to emit wastes in the air and water or it cangive individuals the right to clean air and

water.


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Recycling Recycling may be a less efficient and more

polluting use of labor, land and capital than

simple land fill disposal because: Collecting waste for recycling costs three

times as much as collecting it for disposal.

Rural land is inexpensive.

Recycling paper creates more water pollutionand does not save trees; it simply reducesthe number that are planted.


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Regulatory Solutions

Instead of using market

forces to force firms tointernalize externalities, we

can use emission standards

and apply these to all

market players.


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Global Externalities

CFCs

Deforestation

Global Warming


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Cost Benefit Analysis Net present value (NPV)

Internal rate of return (IRR)

Net benefit investment ratio (NBIR)

Domestic resource cost ratio (DRCR)

Benefit cost ratio (BCR)


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NPV

NPV =

How to decide the appropriate discount rate

to be used in the FA?

n

t

t

tt

r

CB

0 1


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IRR (2) Calculate IRR on the residual cash flow=>

if > TRR, then accept the larger project

Advantages:

Not directly rely on the selection ofdisct rate

Commonly used in commercial field


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IRR (3) Disadvantages:

Need to hv at least one -ve cash flow period

to make the NPV=0

Not unique

Cant be used to rank a group of independent

projects whose IRR > TRR if there is a singleperiod budget constraint


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NBIR (1) Def.: Ratio of the PV of the projects

benefits, net of operating costs, to the PV

of its investment costs

NBIR =

n

t

t

t

n

t

t

tt

r

IC

r

OCB

00 )1()1(

)(


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NBIR (2) NBIR shows the value of the projs

discted benefits, net of OC, per unit of

invt

NBIR > 1 => accept Advantage: correct criterion to use if there

is a single period budget constraint

Disadvantages Not suitable for mutually exclusive projects

Difficult to hv consistent conventions in

allocating certain costs between IC and OC


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DRCR (1) Ratio of PV of the projects net domestic

resource costs to PV of theprojects net FX

earnings

DRCR:

)($)1(

)()($)1()(

0

USrCBL

rBC t

tftf

n

tttltl


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DRCR (2) DRCR < = OER => The project shouldproceed if it uses less domestic resources,

measured in local prices, to earn a unit of

FX than is the norm for the whole

economy.

Adv.: avoid (postpone if EA) the need to

specify a shadow exchange rate in advance

Disadv.:

Cant be use for single period BC and

mutually exclusive projects if both


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BCR (1) Ratio of the sum of the projects disct

benefits to the sum of its discted

investment and OCs

BCR :

t

tn

tt

t

r

C

r

B

)1()1(0


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BCR (2) If BCR> =1(disctedbenefit>discted costs)

Adv.: Easy to show the impact of a % D in

costs/benefits on theprojects viability

Disadv.:

Cant be used for mutually exclusive projects and

single period budget constraint

Need to adhere to conventions regarding the

designation of expenditures as costs & benefits

Lecture 17 March

Documents

Transcript of Lecture 17 March