Jeopardy

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Jeopardy
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Click here for Final Jeopardy
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Fundamentals
NPV and Alternatives
Benefits 1
Benefits 2
Renewables
Costs
10 Point
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20 Points
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30 Points
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40 Points
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50 Points
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4
The approximate efficient level of production
consumption on the graph below and the efficiency
criterion you used
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What is 5 and MBMC?
Marginal Benefits
Marginal Costs
Total Benefits
Net Benefits
Total Costs
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1. The definition of Pareto Criterion
2. The definition of Kaldor-Hicks Criterion
3. The one that is more useful as a criterion public
   policy

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a. Pareto Criterion A policy change is an
improvement if at least some people are made
better off and no one is made worse off b.
Kaldor-Hicks Criterion world is made better off
overall (welfare improvement) if size of gains
and size of losses are such that gainers could
fully compensate losers and still be better off
(potential Pareto Improvement c. Kaldor-Hicks
is more useful There are virtually always losers,
someone is inevitably made worse off Remember
Kaldor-Hicks Criterion is a necessary condition
for satisfying the strict Pareto Criterion
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This type of bias arises in models if a variable
that is correlated both with the dependent and
(at least one of the) independent variables, is
not included in the model.
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Omitted Variable Bias Wrong Functional Form When
functional form is incorrect, e.g. an interaction
term is incorrectly omitted, then the inference
will be biased. Errors in variables bias
measurement error of variable Sample Selection
Bias FDR election projection example. Collect
sample in a way that avoids sample selection.
Construct models for the excluded
variable. Simultaneous Causality Bias e.g supply
and demand. A regression of quantity againgst
price wont be very informative as the two
simultaneously influence each other.
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The future value of 1 today, at future time t,
with discount rate r
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• FV(1r)t
• Recall This is called compounding
• Discounting PV FV/(1r)t
• we use compounding and discounting so we can
  compare value of goods across time periods.
  Otherwise we are comparing apples and oranges.
• Not the same as real vs. nominal

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Can choice of discount rate affect the public
policy decision and how?
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Yes When there is a difference in spread between
fixed costs and operating costs between
projects Ex. Project 1 very High fixed costs,
very low operation costs Project 2 Low fixed
costs, and high operating costs Low discount
rate prefers project 1 High discount rate
prefers project 2
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Cost-Benefit Ratio equation and criteria project
choice.
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B/C Discounted present value of benefits divided
by discounted present value of costs Project
admissible if B/Cgt1 Project preferred if it has
greatest B/C ratio
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NPV Criteria and Equation
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NPV sum( (Bt-Ct)/(1r)t) Admissable if NPV
positive Project with Greatest NPV preferred
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Does B/C analysis lead to an efficient result?
Why or Why not?
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• Does not always pass Kaldor-Hicks test
• Scale is ignored not taking into account
  different sizes of projects
• Can be manipulated by shifting benefits to costs
  or vice versa- particularly important with
  externalities

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Definition Social discount rate and why its
different from the private rate of return.
21

• SDR relative valuation placed by society on
  future consumption that is presently sacrificed
• Aggregation of individual consumption rates of
  interest
• Different because
• Concern for future generations may not be
  reflected in private market
• However remember, political time horizon may be
  shorter, and individuals may be concerned about
  future generations
• Paternalism people systematically discount
  future excessively myopic

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3 out of 7 choices/issues for conducting NPV
analysis
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5. Consider Real Costs and Real Benefits
Correct concept of real costs a. Opportunity cost
is what matters (e.g. value of land whether
purchased or condemned) b. Do not include
transfers (e.g. taxes, turnpike tolls) only
real resource costs (capital labor) Correct
concept of real benefits a. Total WTP/WTA for
relevant goods or services (area under demand
curve) b. Cost of an alternative is just that a
cost, not a benefit (c/e does not imply bgtc)
LATER c. Not just financial benefits, but all
true benefits 6. Uncertainty 7. Broader Issues
Necessary and Sufficient Conditions?
1. Defining the Limits of the Analysis
Geographically Temporally Primary, secondary
impacts 2. Jobs Generally, labor belongs on
the cost side (tie one hand behind their
backs) Politicians typically view job-creation
as a benefitof public projects 3. Beware of
Double-Counting Example of agricultural
irrigation project a. Present value of increased
stream of net revenue from farming b. Increased
value of land 4. Comparing Projects of Different
Lengths (in Time) Two methods (identical
results) 1. Replicate shorter project
re-calculate 2. Equivalent Annual Net Benefit
(later)
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Definition Economic Cost
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• The economic cost of an activity is the value of
  whatever must be given up for the activity
  (opportunity cost)
• Opportunity cost typically exceeds monetary
  outlays
• Transfers between members of society, such as
  taxes paid by firms or individuals to
  governments, should not be counted as costs
• Any social deadweight loss from taxation and any
  labor costs to collect and process taxes,
  however, should be counted

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Economic Concept for gauging consumer and firm
response to regulation
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Elasticity Elasticity percent change in
quantity for 1 change in price, holding all
other variables constant - if quantity very
responsive to price then elastic, if not very
resonponsive than inelastic
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Name and Definition 3 out of 5 Components of
Regulatory costs
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• 1. Real Resource Compliance Costs
• Purchase, installation, operation, and
  maintenance costs of control technologies
• Costs of changes in production inputs and
  processes
• Costs of time spent preparing permit
  applications, reports, etc.
• 2. Government Regulatory Costs
• Costs of administering, monitoring, and
  enforcing regulation
• 3. Social Welfare Costs
• Losses in consumer and producer surplus due to
  increase in price or decrease in output of goods
  and services
• 4. Transitional Costs
• Costs of reallocating resources due to
  regulation
• 5. Indirect Costs
• Costs of changes in market structure, such as
  increased market power
• Costs of changes in product quality
• Forgone benefits of discouraged investment
• REMEMBER Depending on relative importance types
  of costs will dictate which method cost analysis
  is appropraite

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Name and definition all 3 Cost estimation Methods
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• 1. Direct Compliance Cost Method
• Sum up compliance costs obtained from
  engineering estimates, and multiply by quantity,
  then possibly add government administrative costs
• Assumes no behavioral response
• Least expensive method of cost analysis
• May be appropriate when elasticities (behavioral
  responses) are small or compliance costs (and
  price increases) are small
• 2. Partial Equilibrium Analysis
• Look at effects on supply and demand in affected
  market
• Incorporates behavioral responses
• But assumes that effects of regulation are
  confined to one market or a few
• Cose decrease in CSPS
• 3. General Equilibrium Analysis probably
  necessary for power sector regs
• Look at effects on all sectors of economy
• Complex and expensive, but may be necessary if
  regulating a key industry
• Two principal approaches input / output (I/O)
  models and computable general equilibrium (CGE)
  models

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Area indicating Partial Equilibrium Cost of
change below
Price
C
S1
S0
D
F
B
D
A
Quantity
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ABDF
Price
C
S1
S0
D
P1
F
P0
B
D
A
Quantity
Q1
Q0
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Definition WTP and WTA
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Measures for Environmental Goods Marginal
Willingness to Pay (MWTP) DemandMB Measures
for Environmental Bads Marginal Willingness to
Accept (MWTA) Total WTP is area under MWTP -
aggregate of WTP is total benefit
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Initial objective most benefit estimation methods
in environmental policy domain
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Estimate of relevant demand function RECALL Demand
function MB MWTP
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Names of 3 out of 4 types of methods used to
estimate demand (WTP/WTA) for environmental goods
and services
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• REVEALED PREFERENCE METHODS
• use peoples observed behavior in markets to infer
  their WTP for environmental goods
• Prefered by economists b/c reliable
• STATED PREFERENCE METHODS design surveys
• EXPERIMENTAL METHODS constructed market, choice
  real, context artificial
• OFFICIAL REFERRENDA constru ted market, works
  provided using tax limited application
• Criteria choice accuracy (Bias), precision
  (variance)

40
Name at least 4 problems that may arise from the
use of a Recreation Demand Model
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- Omitted Variable Bias. Income, or education
systematically overestimate - Substitute Sites.
lead to a biased estimate of CS for the site in
question, if the travel cost to visit a
substitute site was correlated with the travel
cost to visit the lake. - Trip length.
Variability likely to cause a lot of variance,
although there could also be some bias. - User
Value. The travel cost method only captures user
value, and cannot be used to infer option or
existence value. This could cause a downward bias
on the estimate of CS. - Non-Users. The simplest
model assumes non-visitors have zero valuation
for the site. Below some threshold level of WTP,
some individuals do not show up thus,
-gt"truncation bias" arises. - Multiple purpose
trips. The "travel cost" is therefore potentially
confounded. - Congestion effects. When more
people are using the site you yourself may derive
less benefits from fishing, and therefore your
opportunity cost could be higher than what we've
measured.
42
Name an Advantage and Disadvantage of Contingent
valuation, Hotelling-Clawson-Knetch Method,
Hedonic Property Method, Hedonic Wage Method and
an example of when each could be used
43
Answer on Chart
44
Since MWTP is difficult measure can we use
avoided cost? What is avoided Cost?
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Avoided-cost measure of benefits attempt to use
cost of an alternative means of achieving the
same objective as a measure of the benefit of
achieving the objective proxy benefits NOT A
SUBSTITUTE FOR MWTP not a measure of benefits at
all, all project will pass such a test Cost
effectiveness analysis is not economic efficiency
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Definition Hedonic Methods
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• Hedonics- price of a conventional good varies as
  quantity of closely related environmental good
  changes
• Use information on attributes to explain
  variations in price
• -Wage determinants include worker characteristics
  and job characteristics
• Housing Determinants include attributes of
  structure, neighborhood, and environment
• Steps
• Estimate Hedonic price function by regressing
  price on attributes
• Estimated Coefficients are the marginal WTP for
  respective attributes

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Name definition all components Benefits
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• 1. Use Value value from using the good or
  service, directly or indirectly
• Non-Use Value
• 2. Existence Value
• The value to society of knowing that an
  environmental resource exists
• 3. Option Value
• The value to society of having an option to use
  an env. resource

50
Define the model and Name major problem each
Averting Behavior Methods, Societal Revealed
Preference, Cost-Of Illness Method
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• Averting Behavior methods infer WTP from
  expenditures for risk averting activities
  (revealed pref approach)
• actions based on perceieved benefits, not
  objective
• Data requirements considerable
• Difficult separate risk reduction benefits from
  other benefits, and negative benefits (bottled
  water, helmets)
• Societal Revealed Preference infer benefits from
  costs of previous regulatory actions (bad method)
• regulatory action must be known to have benefits
  greater than cost
• No basis in economic theory, not revealed
  preference method, just cost-effectiveness
  comparison, at most
• Cost-of-Illness Method change in explicit market
  costs resulting fromc hange in incidence of
  illness direct health-care costs, indirect costs
  loss work
• - leaves out pain and suffering

52
Definition Contingent Valuation Method and at
least 3 potential problems
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Contingent valuation method uses a highly
structured survey to consumers/citizens to
determine the value they place on change in
service -Only valuation that can be used to
estimate non-use value Potential Problems
Respondents do not understand what theyre being
asked to value (greater variance, bias?)
Hypothetical not taken seriously because no
budget constraint (greater variance, also
bias?) Strategic bias problem if too
realistic (trade-off between bias and variance)
Insensitivity to scope has been observed,
example of inconsistency with economic theory
(but shape of demand function? behavioral
economics explanation?) Starting point bias
Warm glow effect people simply purchase
moral satisfaction with big, but unreal answers
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Name of Point A
Critical Depensation
Growth Rate Stock
S
A
B
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A Minimal Viable Population (Unstable) B
Natural Equilibrium Carrying capacity (stable)
Critical Depensation
Growth Rate Stock
S
A
B
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Maximum Sustainable Yield Effort
Benefits and Costs of Fishing Effort
Total Cost
A
B
C
Fishing Effort
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1. Efficient Effort
2. Maximum Sustainable Yield
3. Competitive Effort

Benefits and Costs of Fishing Effort
SlopeMB
Total Cost
Ee
EMSY
Ec
Fishing Effort
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Level MUC at the competitive equilibrium,
why? And Stock compared to efficient level
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Zero - no incentive for individual fisher to take
into account future value MUC, leading to too
much effort, a lower stock than efficient
Benefits and Costs of Fishing Effort
Total Cost
SlopeMB
MUC
Ee
EMSY
Ec
Fishing Effort
60
Reason why in open access get EC (two types
externalities)
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Contemporaneous externality one fisher affects
another ( if I catch you cant, and vice
versa) Intertemporal Externality take today,
less tomorrow for all not take into account
future value MUC (Why hotelling rule for
non-renewables required secure property rights)
62
Name three policy choices, examples each, and say
whether efficient and why
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• Privatization
• if resource not very mobile, can contain with
  barriers, or species instinctively return to
  identifiable location
• Is efficient
• 2. Regulatory
• ex. Limit season, use technology, limit available
  harvesting area
• Not efficient because scarcity rent is still
  gone, eaten up with costs
• 3. Tax- efficient

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Final Jeopardy
Make your wager
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• Demand for preservation of each user hiking trail
  
• q 20 - (0.2)(P)
• 1000 users
• Cost preservation per mile 50,000 paid by public
• How many miles should efficiently be preserved?
• What are the total annual benefits and total
  annual costs of this preservation?
• What is consumer surplus?

66

• q10
• TB 750,000,
• TC 500,000
• c. CS 750,000