Fluent Essays

Please write two, 600 word essays that address the following concepts. Discuss the concepts themselves as well as the relationship between the concepts. You will want to include graphs, diagrams and figures to help illustrate key concepts. Please be sure to use other sources of information as needed. It is very important that you properly reference your sources of information. Cite your sources cannot be overemphasized. Always give credit where credit is due!a) Benefits and costs of emissions - the trade offsb) Economic perspectives and the quality of the environment - are they at odds? Why or why not? evaluating_trade_offs.pdf economics_of_environmental_quality.pdf Unformatted Attachment Preview Evaluating Trade-Offs: Benefit-Cost Analysis and Other Decision-Making Metrics No .sensible decision can be made any longer without taking into account not only the world as it is, but the world as it will be .... -Isaac Asimov, US science fiction novelist and scholar (1920-1992) Introduction In the last chapter we noted that economic analysis has both positive and nor-· mative dimensions. The normative dimension helps to separate the policies that make sense f rom those that dont. Since resources are limited, it is not possi­ ble to undertake all ventures that might appear desirable so making choices is inevitable. Normative analysis can be useful in public poli cy in several different situations.. It might be used, for example, to evaluate the desirability of a proposed new pollution control regulation or a proposal to preserve an area currently scheduled for devel­ opment. In these cases, the analysis helps to provide guidance on the desirability of a program before that program is put into place.. In other contexts, it might be used to evaluate how an already-implemented program has worked out in practice.. Here the relevant question is: Was this a wise use of resources? In this chapter; we present and demonstrate the use of several decision-making metrics that can assist us in evaluating options. Normative Cr_iteria for Decision Making Nonnative choices can arise in two different contexts .. In the first context, we need simply to choose among options that have been predefined, while in the second we try to find the optimal choice among all the possible choices. 46 Normative Criteria for Decision Making Evaluating Predefined Options: Benefit-Cost Analysis If you were asked to evaluate the desirability of some proposed action, you would probably begin by attempting to identify both the gains and the losses from that action. If the gains exceed the losses, then it seems natural to support the action. That simple framework provides the starting point for the normative approach to evaluating policy choices in economics. Economists suggest that actions have both f benefits and costs I the benefits exceed the costs, then the action is desirable.. On the other hand, if the costs exceed the benefits, then the action is not desirable.. (Comparing benefits and costs across time will be covered later in the Chapter) We can formalize this in the following way. Let B be the benefits from a pro­ posed action and C be the costs Our decision rule would then be if B > C, support the action.. Otherwise, oppose the action. 1 As long as B and Care positive, a mathematically equivalent formulation would be if B / C > 1, support the action. Otherwise, oppose the action.. So far so good, but how do we measure benefits and costs? In economics, the system of measurement is anthropocentric, which simply means human centered. All benefits and costs are valued in terms of their effects (broadly defined) on humanity. As shall be pointed out later; that does not imply (as it might first appear) that ecosystem effects are ignored unless they direttly affect humans . The fact that large numbers of humans contribute voluntarily to organizations that are dedicated to environmental protection provides ample evidence that humans place a value on environmental preservation that goes well beyond any di rect use they might make of it Nonetheless, the notion that humans are doing the valuing is a controversial point that will be revisited and discussed in Chapter 4 and 13 along with the specific techniques for valuing these effects. In benefit-cost analysis, benefits are measured simply as the relevant area under the demand curve since the demand curve reflects consumers willingness to pay. Total costs are measured by the relevant area under the marginal cost curve. It is important to str·ess that environmental services have costs even though they are produced without any human input All costs should be measured as opportu­ nity costs. To firm up this notion of opportunity cost, consider an example. Suppose a particular stretch ofriver can be used either for white-water canoeing or to gener­ ate electric power.. Since the dam that generates the power would flood the rapids, the two uses are incompatible. The opportunity cost of producing power is the foregone net benefit that would have resulted from the white-water canoeing.. The marginal opportunity cost curve defines the additional cost of producing another unit 1Actuall if B = C, it wouldnt make any difference if the action occurs or not; the benefits and costs y are a wash 47 48 Chapter 3 Evaluating Trade-Offs: Benefit-Cost Analysis and Other Decision-Making Metrics of electricity resulting from the associated incremental loss of net benefits due to reduced opportunities for white-water canoeing. Since net benefit is defined as the excess of benefits over costs, it follows that net benefit is equal to that portion of the area under the demand curve that lies above the supply curve . Consider Figure 3.1, which illustrates the net benefits from preserving a stretch of river. Suppose that we are considering preserving a 4-mile str·etch of river and that the benefits and costs of that action are reflected in Figure 3 .1. Should that stretch be preserved? Why or why not? Hold your answer because we will return to this example later:. Finding the Optimal Outcome In the preceding section, we examined how benefit-cost analysis can be used to evaluate the desirability of specific actions . In this section, we want to examine how this approach can be used to identify optimal, or best, approaches. In subsequent chapters, which address individual environmental problems, the normative analysis will proceed in three steps . First, we will identify an optimal outcome . Second, we will attempt to discern the extent to which our institutions produce optimal outcomes and, where divergences occur between actual and optimal outcomes, to attempt to uncover the behavioral sources of the problems . Finally, we can use both our knowledge of the nature of the problems and their underlying behavioral causes as a basis for designing appropriate policy solutions . Although applying these three steps to each of the environmental problems must --�-•= The Derivation of Net Benefits I I . Price (dollars 10 per unit) 9 8 7 6 5 4 3 2 1 Total Cost ----1· ·-·---��-·-•m. Normative Criteria for Decision Making reflect the uniqueness of each situation, the overarching framework used to shape that analysis remains the same. To provide some illustr ations of how this approach is used in practice, consider two examples: one drawn f rom natural resource economics and another from envi­ rnnmental economics.. These are meant to be illustrative and to convey a flavor of the argument; the details are left to upcoming chapters. Consider the rising number of depleted ocean fisheries. Depleted fisheries, which involve fish populations that have fallen so low as to threaten their viability as commercial fisheries, not only jeopardize oceanic biodiversity, but also pose a threat to both the individuals who make their living from the sea and the communities that depend on fishing to support their local economies.. How would an economist attempt to understand and resolve this problem? The first step would involve defining the optimal stock or the optimal rate of harvest of the fishery. The second step would compare this level with the actual stock and harvest levels.. Once this economic framework is applied, not only does it become clear· that stocks are much lower than optimal for many fisheries, but also the reason for excessive exploitation becomes clear. Understanding the nature of the problem has led quite natu rally to some solutions. Once implemented, these policies have allowed some fisheries to begin the process of renewal. The details of this analysis and the policy implications that flow from it are covered in Chapter 12.. Another problem involves solid waste. As local communities run out of room for landfills in the face ofan increasing generation of waste, what can be done? Economists start by thinking about how one would define the optimal amount of waste. The definition necessarily incorporates waste reduction and recycling as aspects of the optimal outcome .. The analysis not only reveals that current waste lev­ els are excessive, but also suggests some specific behavioral sources of the problem .. Based upon this understanding, specific economic solutions have been identified and implemented Communities that have adopted these measures have generally experienced lower levels of waste and higher levels of recycling . The details are spelled out in Chapter 8.. In the rest of the book, similar analysis is applied to energy, minerals, water, pollution, and a host of other topics.. In each case, the economic analysis helps to point the way toward solutions .. To initiate that process, we must begin by defining optimal.. Relating Optimality to Efficiency According to the normative choice criterion introduced earlier in this chapter, desi rable outcomes are those where the benefits exceed the costs .. It is therefore a logical next step to suggest that optimal polices ar·e those that maximize net benefits (benefits minus costs).. The concept of static efficiency, or merely efficiency, was intro­ duced in Chapter 2 .. An allocation ofresources is said to satisfy the static efficiency criterion if the economic surplus from the use of those resources is maximized by that allocation. Notice that the net benefits area to be maximized in an optimal outcome for public policy is identical to the economic surplus that is maximized in an efficient allocation .. Hence, efficient outcomes ar·e also optimal outcomes. 49 50 Chapter 3 Evaluating Trade-Offs: Benefit-Cost Analysis and Other Decision-Making Metrics Lets take a moment to show how this concept can be applied .. Previously, we asked whether an action that preserved four miles of river was worth doing (Figure 3 . 1 ).. The answer is yes because the net benefits f rom that action are posi­ tive .. (Can you see why?) Static efficiency, however; requi res us to ask a rather different question, namely, what is the optimal (or efficient) number of miles to be preserved? We know from the definition that the optimal amount of preservation would maximize net ben­ efits.. Does preserving 4 miles maximize net benefits? Is it the efficient outcome? We can answer that question by establishing whether it is possible to increase the f net benefit by preserving more or less of the river. I the net benefit can be increased by preserving more miles, clearly, preserving 4 miles could not have maximized the net benefit and, therefore, could not have been efficient Consider what would happen if society were to choose to preserve 5 miles instead of 4 . Refer back to Figure 3 .L What happens to the net benefit? It increases by area MNR. Since we can find another allocation with greater net benefit, 4 miles of preservation could not have been efficient. Could 5? Yes. Lets see why f We know that 5 miles of preservation convey more net benefits than 4. I this allocation is efficient, then it must also be true that the net benefit is smaller for lev­ els of preservation higher than five . Notice that the additional cost of preserving the sixth unit (the area under the marginal cost curve) is larger than the additional ben­ efit received from preserving it (the corresponding area under the demand curve).. Therefore, the triangle RTU represents the reduction in net benefit that occurs if 6 miles are preserved rather than 5 . Since the net benefit is reduced, both by preserving less than five and by pre­ serving more than five, we conclude that five units is the preservation level that maximizes net benefit (the shaded area). Therefore, from our definition, preserving 5 miles constitutes an efficient or optimal allocation . 2 One implication of this example, which will be very useful in succeeding chapters, is what we shall call the first equimarginal principle: First Equimarginal Principle (the Efficiency Equimarginal Principle): Social net benefits are maximized when the social marginal benefits from an allocation equal the social marginal costs. The social marginal benefit is the increase in social benefits received from supplying one more unit of the good or service, while social marginal cost is the increase in cost incurred from supplying that additional unit of the good or service This criterion helps to minimize wasted resources, but is it fair ? The ethical basis for this criterion is derived from a concept called Pareto optimality, named after the Italian-born Swiss economist Vtlf redo Pareto, who first proposed it around the turn of the twentieth century. f Allocations are said to be Pareto optimal i no otherfeasible allocation could benefit at least one person without any deleterious effects on some other person. 2The monetary worth of the net benefit is the sum of two ri ht trian les, and it e uals g q g (1/2)($5)(5) + (1/2)($2 50)(5) or $18.75 .. Can you see why? Normative Criteria for Decision Making Allocations that do not satisfy this definition are suboptimal. Suboptimal alloca­ tions can always be rearranged so that some people can gain net benefits without the rearrangement causing anyone else to lose net benefits. Therefore, the gainers could use a portion of theifr gains to compensate the losers sufficiently to ensure they were at least as well of as they were prior to the reallocation.. Efficient allocations are Par·eto optimal. Since net benefits ar·e maximized by an efficient allocation, it is not possible to increase the net benefit by rearranging the allocation. Without an increase in the net benefit, it is impossible for the gainers to compensate the losers sufficiently; the gains to the gainers would necessarily be smaller than the losses to the losers . Inefficient allocations are judged inferior because they do not maximize the size of the pie to be distributed.. By failing to maximize net benefit, they are forgoing an f opportunity to make some people better of without harming others. Comparing Benefits and Costs across Time The analysis we have covered so far is very useful for thinking about actions where time is not an important factor.. Yet many of the decisions made now have consequences that persist well into the future.. Time is a factor. Exhaustible energy resources, once used, are gone. Biological renewable resources (such as fisheries or forests) can be overharvested, leaving smaller and possibly weaker populations for future generations. Persistent pollutants can accumulate over tirne . How can we make choices when the benefits and costs occur at different points in time? Incorporating time into the analysis requires an extension of the concepts we have already developed. This extension provides a way for thinking not only about the magnitude of benefits and costs, but also about their timing.. In order to incorporate timing, the decision rule must provide a way to compare net benefits received in different time periods.. The concept that allows this comparison is called present value. Therefore, before introducing this expanded decision rule, we must define present value. Present value explicitly incorporates the time value of money. A dollar today invested at 10 percent interest yields $110 a year from now (the return of the $1 principal plus $0. 10 interest).. The present value of$ L10 received one year from now is therefore $1, because given $1 now, you can turn it into $1.10 a year from now by investing it at 10 percent interest. We can find the present value of any amount of money (X) received one year from now by computing X/(1 + r), where r is the appropriate interest rate (10 percent in our above example}. What could your dollar· earn in two years at r percent interest? Because of com­ pound interest, the amount would be $1(1 + r)(l + r) = $1(1 + r)2 It follows then that the present value ofX received two years from now is X/(1 + r)2 . By now the pattern should be clear. The present value of a one-time net benefit received n years from now is PV[B.] B. (1 + r) 51 Chapter 3 52 Evaluating Trade-Offs: Benefit-Cost Analysis and Other Decision-Making Metrics T he present value of a stream of net benefits {Bo, .... , En} received over a period of n years is computed as n B BJ= n PV[Bo, .... I �(1 + rY where r is the appropriate interest rate and Bo is the amount of net benefits received immediately. The process of calculating the present value is called discounting; and the rate r is referred to as the discount rate. The number resulting f rom a present-value calculation has a straightforward interpretation . Suppose you were investigating an allocation that would yield the following pattern of net benefits on the last day of each of the next 5 years: $3,000, $5,000, $6,000, $10,000, and $12,000 . If you use an interest rate of 6 percent (r = 0..06) and the above formula, you will discover that this str earn has a present value of $29,205 .92 . (see Table 3..1).. Notice how each amount is discounted back the appropriate number of years to the present and then these discounted values are summed.. What does that number mean? If you put $29,205 ..92 in a savings account earning 6 percent interest and wrote yourself checks, respectively, for $3,000, $5,000, $6,000, $10,000, and $12,000 on the last day of each of the next 5 years, your last check would just restore the account to a $0 balance (see Table 3..2) . Thus, you should be indifferent about receiving $29,205 .. 92 now or in the spe­ cific 5-year stream of benefits totaling $36,000; given one, you can get the other Hence, the method is called present value because it translates everything back to its curTent worth. It is now possible to show how this analysis can be used to evaluate actions. Calculate the present value of net benefits from the action .. If the present value is greater than zero, the action can be supported .. Otherwise it should not. TABLE:tJ,, - -� � , y Demonstrating Present Value Calculations Year 1 2 3 4 5 Sum $3,000 $5,000 $6,000 $10,000 $12,000 $36,000 $2,830 19 $4,449..98 $5,03772 $7,920.94 $8,96710 $29,205.92 Annual Amounts Present Value (r = 0 06) Interpreting Present Value Calculations Year Balance at Beginning of Year 2 3 4 5 $29,205.92 $27,958.28 $24,635.77 $20, 113 .92 $11,320 75 $0 00 Year-End Fund Balance before $30,958.28 $29,63577 $26, 113.92 $21,320.75 $12,000..00 Payment (r=O 06) Payment 6 $3,000 $5,000 $6,000 $10,000 $12,000 Applying the Concepts Dynamic Efficiency The static efficiency criterion is very useful for comparing resource allocations when time is not an important factor. How can we think about optimal choices when the benefits and costs occur at different points in time? The traditional criterion used to :find an optimal allocation when time is involved is called dynamic efficiency, a generalization of the static efficiency concept already developed . In this generalization, the present-value criterion provides a way for comparing the net benefits received in one period with the net benefits received in another. An allocation of resources across n time periods satisfies the dynamic efficiency criterion if it maximizes the present value of net benefits that could be received from all the possible ways of allocating those resources over the n periods . 3 Having now spent some time developing the concepts we need, lets take a moment to examine some actual studies in which they have been used . Pollution Control Benefit-cost analysis has been used to assess the desi rability of efforts to control pollution. Pollution control certainly confers many benefits, but it also has costs. Do the benefits justify ... Purchase answer to see full attachment