ENV & NAT RESOURCE ECON
ENV & NAT RESOURCE ECON AGEC 350
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Date Created: 10/21/15
Selected brief answers for review questions for rst exam Fall 2006 AGEC 350 Don 39t forget you may bring a 3x5 notecard t0 the exam These are brief answers intended to help you nd the complete answers In most cases I would expect a more complete answer on the exam While I don t actually draw graphs in these notes I make reference to graphs thatI hope are sufficient for you to understand what I m saying If you re still in doubt contact me and I ll clear it up If you re still confused consult with Dr Woodward or attend one of the review sessions Good luck Guest Lecture Don t forget to review your notes from the discussion lead by Dr Ed Powell of TXU and Paul Rolke of Our Land Our Lives There will be a question over that material Discounting amp Present Value 1 N W 8 PV of costs 47 PV ofbene ts 211221132114l65l50l37452 PV of Bene ts lt PV of Costs 3 Don t do it Since we now pay costs in the future the PV of costs 471 l2388 Hence now the PV of costs are less than the bene ts so yes your recommendation would change Fquot As seen in the table below the PV of net bene ts is just barely positive Hence you can make money by taking a loan from the bank and investing the money with your cousin Ralph Adding up the costs and bene ts over time does not take into account the timevalue of money and therefore does not correctly account for the opportunity costs For example a project that leads to 10 thousand in bene ts every year for 100 years would be seen as equivalent to a project that leads to 100 thousand in bene ts for 10 years Yet the second project is more desirable because after 10 years we could invest more money in other projects Money has value over time if it is not locked up in one project it can generate other bene ts elsewhere Failing to take into account this opportunity cost leads to socially inef cient policies Dynamic Ef ciency and nonrenewable resources 4 An allocation is dynamically ef cient if the present value of net benefits is maximized This is satis ed if the present value of the marginal net benefits of the resource used in each period is equal U 0quot gt1 8 This is a trick question False The Present Value of the MNB in each period should be equal We can see that this maximized the PV of net bene ts as follows Suppose it is not true that the PV of the MNB in the next period is higher than the PV of MNB of use this period In this case a slight increase in consumption next period made possible by a slight reduction in consumption today would have bene ts in terms of the PV of net bene ts that are greater than the cost If the PV of MNB is equal across periods and we discount future bene ts then the MNB in future periods measured in future period dollars will exceed the MNB in the current period The PV of the marginal net bene ts must be equal in a dynamically efficient allocation Using a two period example periods 0 and 1 we could write this PVMNB0 PVMNB1 Since the PV s are equal this means that the marginal net benefits in the future without discounting is greater than the marginal net bene ts in the present ie MNB1gtMNB0 Since MNB MWTP MC if the MC is the same in the present and the future this means the MWTP1gtMWTP0 The price in the marketplace must be equal to the marginal bene ts since if the price is less than that level demand will exceed supply ie P1 MWTPI and P0MWTP0 Hence we arrive at the conclusion that P1gtP0 More intuitively since the dynamically ef cient allocation usually leads to falling consumption over time scarcity increases and prices will respond to the increasing scarcity Finally a third way to look at it is from the producer s perspective Unless the price is growing over time they will have an incentive to withdraw all of their reserves right now and then put their money in the bank Since we don t see that happening we can conclude that producers must expect the price to rise over time You will be expected to understand all of these explanations A backstop technology places an upper limit on the market39s willingness to pay for a resource For example if solar energy can create electricity at 10 per megawatt then no one will pay more than 10megawatt for a electricity generated from oil quantity of oil that could produce that much electricity Hence backstop technologies set an upper limit on the price both now and in the future Given that the PV of net benefits will still tend to rise over time this will push the price down in the present before we adopt solar energy As explained in class a 10 8 102 1 1 6 4 CosT foregone 2 unit Today b By drawing the MNB curve on top of the MUC curve we can identify the optimal intertemporal allocation The intersection occurs slightly to the right of the equal split 3 1 O 8 11012 6 4 Cost 2 1 0 2o 30 40 Q A little more than half of the resource would be consumed in the initial period ie a little more than 25 units Hence the marketclearing price would need to be a little lower in the rst period than in the second period as seen in the graph below 10 0 10 2o 30 40 Q 9 No First because there will be new discoveries and depending on prices costs and technologies the percentage of the oil that we will be able to extract will change over time Second for economic reasons as we approach the end of our supply the price will probably increase sharply and this will diminish demand and thereby put off the extraction of the last drop of oil probably inde nitely Finally since there are backstop technologies it will never make sense to extract oil at a cost that is higher than the cost of producing an alternative Hence some of the oil will inevitably be left in the ground 10 step 1 Find the MNB curve by subtracting MC from WTP Note that the MNB curve staIts at 18 612 and ends where MB MC at Q10 O 2 4 6 8 10 step 2 Calculate the PV of NB 8 step 3 Flip it around to get the marginal user cost Since there are only 10 units available the MUC curve starts at Q0 8 Cost Q Today O 2 4 6 8 TO step 4 Find the optimal level of consumption today where MNB MUC 8 Cost Q Today O 2 6 8 Q Today step 5 Now use the demand curve to nd the price that would lead to the optimal level of consumption today and lOQ units in the next period This completes the answer to part a S P Today WTP Q Today 6 8 Q Today step 6 Now since there are 10Q units left for tomorrow nd that price which will be higher 0 2 6 8 10 QT What s left over OTOUOW after 62 Today Forestry 11 The table below provides all the information you would need to answer the questions The biological criterion would have the forest harvested at 60 years The economic criterion would have the forest harvested at 40 years The PV of the forest if harvested at 30 years is 13554 lots more than 3000 so I would not accept the offer of 3000 for the forest NE at time PV of NE includes 123 1005year 20 2180 39 789 40 3845 420 MAI maximized at 40 years 135 54 13662 7656 No the PV of net bene ts is greater than 3000 Better to plant the forest The stumpage value is the value of the bare land Since the maximum present value obtainable from the land is 13662 that is the value of the land to you before planting In the 2nd rotation you would still harvest 40 years after planting Hence the PV of that 2nd rotation at the moment right before planting is 13662 However you don t get to rhymeow 0 plant the second rotation until you ve harvested the rst one The question to consider is whether we want to wait 30 or 40 years to cut the rst one Now in the first rotation by waiting from 30 to 40 years the PV of the bene t goes up to from 13554 to 13662 In other words the bene t of doing a 40 year rotation instead of a 30 year rotation is 108 However by waiting those last 10 years the PV of the 2nd rotation is discounted more from 136621r30 to 136621r4 a decline of1220 Hence the PV of the Bene t of waiting from year 30 to year 40 in the first rotation is less than the PV of the cost Hence it is better to harvest after 30 years in the rst rotation and 40 years in the second rotation The bottom line is that waiting to harvest also means waiting to start the next rotation 7 hence waiting has a user cost N It could be argued that public forest plays the role of providing the nonuse values and private lands provide for the use values associated with timber production The efficient allocation of timber across the country would be where the marginal net bene t of an additional acre in timber production is equal to the marginal net bene t of an acre in nontimber bene ts This might be achieved by dividing ownership as we do in the US 13 A perverse incentive refers to an economic incentive created by a public policy that inadvertently creates socially inef cient results Such incentives lead to unintended consequences 4 Example the taxes and subsidies that encouraged agriculture and grazing led to wasteful destruction of forests U The Endangered Species Act makes it illegal for a landowner to do anything on his or her land that would place at risk an endangered species that resides or could reside on that land Hence landowners have an incentive to shoot shovel and shutup ie eliminate habitat when no one is looking so as to make sure that their land management is not restricted Fisheries 16 Efforf weeks of fishing 4O 5O EMEV EMSV d As long as there are pro ts being made by shermen using the shery there is an incentive for more shermen to enter Hence if there are no restrictions on entry effort will tend to expand until EDA is reached This is inef cient because the net bene ts from the shery are maximized at EMEY while at EDA shing effort generates no net benefits e If there were a tax on effort then the total cost curve would be rotated upward It would be possible to rotate the curve exactly right so that that at EMEY there are no more private pro ts and there would be no more entry The rents generated by the fishery would be taken up by the tax and could be used for public service projects However the shermen would still earn zero pro ts so they wouldn t be any better off than under the original open access situation However the shermen would be no worse off either and the government would receive revenues that they could presumably use to do some good say build school for the shermen s children 17 Consider each of the following types of policies and explain whether i the policy can be effective in reducing over shing ii the policy can achieve an ef cient outcome in terms of the rents generated by the shery and iii the policy leads to an improvement in the welfare of shermen in the fishery a Limits on the season i can reduce shing effort ii however this does not lead to an ef cient outcome because the open access nature of the fishery is not eliminated and shermen just waste effort trying to sh in a shorter season iii It will not usually eliminate the openaccess nature of the shery so that shermen still do not make any pro ts in equilibrium 57 Restrictions in the type of gear that shermen can use i can reduce shing effort and ii however this does not lead to an ef cient outcome because the open access nature of the shery is not eliminated and shermen just waste effort trying to sh with inferior gear iii It will not usually eliminate the openaccess nature of the shery so that shermen still do not make any pro ts in equilibrium 0 A tax on shing effort i can reduce shing effort and ii can lead to an ef cient allocation of the fishery with rents pro ts being transferred to the government in the form of taxes iii A tax will not usually eliminate the openaccess nature of the shery as far as the shermen are concerned so that they still do not make any pro ts in equilibrium d A tax on sh sold reducing the price paid to shermen In the standard model this would lead to a downward shift in the sustainable revenue curve but would not change the open access nature of the shery i effort would fall but ii it would not lead to an ef cient outcome and iii the shermen would be no better off 7 still making zero pro ts in equilibrium e A transferable rights program This is the only approach that can lead to a reduction in shing effort ef cient use of the shery m lead to rents pro ts to the shermen in equilibrium Water 18 If a groundwater reserves recharges slowly then water you take out today means less water available for future use there is a user cost Hence they can be looked at using the same economic model we use to talk about nonrenewable resources Of course if the aquifer is being recharged quickly then use today does not diminish use in the future and the non renewable resource model doesn t t 19 This is a bit of a trick question because the answer is not Xmarks the spot At least not using the graph provided The key point is that the marginal net benefits should be equal across the alternative uses 9 ST The net bene ts to recreation are maximized if they have at least 50 cubic feet per second Similarly the net bene ts to municipal users are maximized if they have at least 40 cubic feet per second Hence if there are 100 cubic feet per second available then the city could use 40 cubic feet and the recreational use could use 50 cubic feet and there would be 10 cubic feet left over If there is only 50 cubic feet per second available then both sectors cannot use as much water as they would like The optimal allocation is found by creating the graph below in which the Marginal net bene ts to the recreational sector is ipped around and the total length of the horizontal axis is 50 the available water supply Now the optimum is found where x marks the spot 7 where marginal net bene ts to the competing uses is equal though the graph needs to be redrawn as below so that it re ects that the two user types must share a common resource When the recreationists are using about 23 cubic feet and the municipal use is using about 27 cubic feet the marginal net benefits are equal at about 35 maximizing total net bene ts and the quantity used is exactly 50 10 10 2o 30 40 50 use gt 50 40 30 20 10 0 4 Recreational use 20 The minimum ow might not be socially efficient For example the minimum ow necessary to ensure the survival of an endangered species may not be sufficient to allow recreational use of a river If the marginal benefits to outofstream uses of the water e g agriculture or municipal use is low and the public would be willing to pay a lot to be able to use the water in stream then increasing instream ows could lead to an increase in social net bene ts This alternative allocation would be better in the sense that total social net bene ts are greater However it is worth noting that this may not be a Pareto efficient change farmers or other users might be made worse off by the change that increases instream ows but decreases water available for extractive use Pollution policies 21 ST 0 F 22 9 Pollution Gross Pro ts MC of Abatement 0 1 2 3 4 5 6 7 8 9 Abatement Twenty You should be able to explain why From the graph we see that the tax rate is greater than the MC of abatement for the first 5 units of abatement Hence the rm would choose to abate 5 units reducing pollution to 15 units Net pro ts would fall to 3451 less the tax on the 15 units of pollution remaining ie 3451 15gtlt103301 Let39s look at the situation if the rm is at 15 permits They have abated 5 units The marginal cost of the previous reduction is 9 and the MC of the next two units of reduction are 11 13 and 15 Hence the rm could reduce 2 more units reducing its emissions to 13 and make money by selling the 2 credits that are generated If both rms are cleaning up 4 units then the cost of the last unit of cleanup cost rm 1 5 and rm 2 10 Total costs could be reduced if rm 1 to cleaned up a little more and rm 2 cleaned up a little less Until the MC of abatement of rm 1 equals that of rm 2 costreducing reallocations can be achieved and the pollution reduction level is not being achieved in the costeffective manner A tax of 5 per unit of pollution would lead rm 1 to clean up 4 units and rm 2 to clean up 2 units for a total clean up of 6 units A subsidy of 15 per unit would lead rm 1 to clean up 7 units and rm 2 to clean up 6 units for a total clean up of 13 units 23 11 d The graph below puts cleanup by rm 1 left to right and rm 2 right to left The TC would be the areas under MCl to the left of 5 and under the MC2 curve to the right of 5 T01 Cleanup 2 4 5 lt6 8 l Firm lgt 8 lt5 4 2 0 lt Firm 2 e If the rms were able to make trades there would be a tendency for rm 1 to clean up more and firm 2 to clean up less The price they would agree on for the first trade would be somewhere between 7 and 12 Theory predicts a nal price of 10 per unit would be the equilibrium leading to a costeffective allocation in which rm 1 abates 6 units and rm 2 abates 4 units quot7 If a ne of 5 were charged firms would tend to under abate Firm 1 would choose to abate 4 units paying a ne of 5 for its remaining unit of pollution and firm 2 would only abate 2 units There would be no trading in such a situation 1 Provides incentives to nd cheaper ways of achieving an environmental goal 2 Allows for trades that would reduce the total cost of achieving the goal 3 by reducing the total cost of achieving an environmental goal it might be possible obtain the political will to achieve a higher environmental standard Two potential problems 1 Implementation costs can be high you have to define the market which is tricky 2 Enforcement costs can be high because it is necessary to evaluate a whether the levels of emissions are being achieved not just if the appropriate equipment is installed and b the regulating agency needs to pay attention to all of the firms before and after they have made trades Trading ratios are frequently used to account for the uncertainty behind the actual reductions that might be achieved by nonpoint sources Hence reductions by nonpoint sources are discounted Trading ratios are also used to adjust for variable bene ts of load reductions because sources are located at different points in the watershed Trading ratios are also sometimes used to manipulate the market to try to get additional pollution reductions through trading This nal reason however can be inefficient because it would be more cost effective to just reduce the total cap on trading and then allow efficient trading without arti cially manipulated trading ratios Water policy and TMDLs 26 One of the key differences is that the Total Maximum Daily Load TMDL process is that it focuses on the total load in the water body which is what society actually cares about instead of the load from individual point sources It also considers pollution from all sources which is an important change 28 Through pollution trading a rm that can reduce pollution at low cost can do so instead of another firm for which the cost is high This means that a pollution reduction goal such as speci ed in a TMDL can be achieved at lower total cost to society 9 ST Firm 139s pro ts are reduced from 915 to 8775 for a cost of 375 Firm 239s pro ts fall from 5492 to 5348 for a cost of 144 The total cost therefore is 519 First trade Firm 1 would be willing to pay up to 1350 for the right to pollute 1 unit more and firm 2 would be willing to pollute 1 less if it was compensated by at least 51 Hence the price would be between 510 and 1350 Now we39re at 16 and 11 Second trade Firm 1 would pay 1050 to pollute 1 more and rm 2 would need to be compensated by at least 57 hence again there s room for a trade Now we39re at 17 and 1 Third Trade Firm 1 would be willing to pay 750 to pollute 1 more ant rm 2 would need to be compensated by at least 630 Still room for a trade Now we39re at 18 and 9 Fourth Trade Firm 1 would be willing to pay only 450 to pollute one more but rm 2 would need to be compensated by 690 Hence the 4th trade is amp feasible and the nal allocation of pollution is 18 and 9 29 mumgm pay fur eredns Explam L aqu Reductmns Laaqu 1951 Lasqu 9 4592 current treatment er 949a standard charm25 73 9729 Maxrmdm charm25 97 4994 std charm25 wNtratmn 93 2432 Bm aqma 73 9729 Bm aqma wNtratmn 93 2432 EMF Generated credxts Cream ha ance Reductmns Reductmn east 4 397 E EE drrenttreatm n 9 221999 standard charm25 4994 4994 29792 19 97 Mam arm 1 9729 9729 31919 15 92 std charm25 wNtratmn 12199 12199 34949 29 27 Bm aqma 4994 4994 29792 9 91 Bm aqma wNtratmn 12199 12199 34949 29 27 costs cast nnrumn doHavSW EMF EMF 5thch east 09M Catha upgrade T9291 Current treatment er 9 99 9 99 9 99 standard charm25 9 45 9 24 9 21 9 45 Maxrmdm charm 9 49 9 29 9 21 9 49 td charm25 wNtratmn 9 99 9 29 9 41 9 99 Bm aqma 9 29 9 99 9 19 9 29 Bm aqma wNtratmn 9 99 9 29 9 41 9 99 Global Warming 30 CO2 and other gases provide a chemical blanket around the earth that causes heat to re ect LN back to the earth s surface As we add gases to this blanket it becomes thicker and the globe s temperature increases The vast majority of scientists agree that this will lead to a warming of the planet over the next century and there is evidence that this warming trend has already begun Global warming is not a scienti c certainty but there is growing evidence that it is happening There is no debate about the concentration of greenhouse gases in the atmosphere it is increasing There is also strong evidence that the planet is warming The earth s temperature rose during the 20th century The National Academy of Science NAS panel concludes despite the uncertainties there is general agreement that the observed warming is real and particularly strong within the past twenty years The question then is whether the increasing concentration of greenhouse gases GHGs has caused the observed warming and whether this means that temperatures will continue to rise during this century as GHG concentrations continue to rise The basic theory behind GHG concentrations and global warming is clear However the reality of the earth s climate is very complex and there are many other factors that in uence the earth s temperature many of which are not yet fully understood The Intergovernmental Panel on Climate Change concludes that most of the recent warming is due to GHGs and the NAS agrees that this re ects the current thinking of the scienti c community and the con dence in the IPCC assessment is higher today than it was ten or even five years ago Hence future anthropogenic global warming is not a scienti c certainty and it may never will be However con dence in this link is growing scienti c consensus on global warming has shifted from possible to probable Where debate remains active is in the area of consequences 7 it is not clear what will happen and where the consequences will be most severe 7 and in policies that should be followed 7 some believe that we should focus on stopping or slowing climate change while others believe we should pay more attention to adapting to a warmer earth 32 a The total cost of a change like global warming is the change in consumer and producer surplus Here s the graph we used in class The shaded area would be the total cost to the economy If warming improved the productivity of the sector then the supply curve would shift right and the gain would be a shaded area on the other side of S Q of Ag Prod Using the example from the lecture we see that the net cost to agriculture will be the decline in pro ts after adjusting to the most pro table crop Hence the true cost of global warming must take into account the potential for substitution WheaT in Arkansas Cam in Arkansas of Wheat The main lesson here is that when there are substitution opportunities the cost of global warming will not be as great as they might first appear This same idea holds true in other instances as well For example in the case of sea level rise the damage will be reduced because as sea levels start to rise people will stop building in threatened areas The costs will be greatest therefore in countries or regions where moving inland is not a possibility ie where substitution options are least 33 The efficient level of global warming would be where the marginal benefit of reducing global warming is equal to the marginal cost both in terms of present value 9 ST 0 Yes it makes a difference how the reduction is going to be implemented because if it were implemented using CampC policies then the cost will be higher than if incentive based taxes subsidies or trading policies are used since those policies tend to be cost effective The basic objective of your work would be to estimate the MC of reducing greenhouse gases by different types of transportation types This is not easy because it will involve a combination of technological innovations and changes in use For example if the tax induces people to drive less then this means that opportunity costs are paid by drivers estimating the value of those costs is difficult At a given tax rate abatement would occur up to the point where the MC of abatement is equal to the tax rate The cost to the industry could then be obtained by adding up the total cost to each of the transportation types If a tax is used then the total cost would be the shaded area under the MC cost curve You might want to conduct a survey of representatives of the transportation industry eg truck and car manufacturers to nd out how much it would cost them to reduce their CO2 emissions In addition you could hire engineers who could evaluate based on their own knowledge the additional costs that would be involved in producing less contaminating vehicles 35 As we saw in the lecture for every ton of C02 produced in developing countries they typically generate much less in total economic output Hence if they are participating in a trading arrangement there is likely to be a lot more trading as the US and other industrialized countries nd that it39s cheaper to buy reductions in developing countries than to actually make the reductions on their own W 0 This is up to you Some points that I would probably introduce into a response to this would be the participation of LDC39s costs to the US economy US role as leader in environmental issues and sustainability
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