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SAMPLE OUTLINE: BENEFIT-COST ANALYSIS
EXECUTIVE SUMMARY
In most cases markets operate to reach an economically efficient
position defined as one that maximizes social welfare measured as
the sum of consumer plus producer surplus
However, there are a variety of conditions that prevent markets from
operating efficiency: externalities and public goods being two
primary examples
This paper describes the nature of public goods and explains why
markets cannot achieve an efficient outcome for them
It then describes two techniques that economists and environmental
analysts often use to determine which market outcome most closely
approximates economic efficiency:
It begins with the more important of the two techniques: costbenefit analysis
It then continues with a more generally useable technique: costeffectiveness analysis
It concludes with a statement about the advantages and disadvantages
of both techniques
OVERVIEW OF ECONOMIC EFFICIENCY AND MARKET FAILURES
Tietenberg and Lewis offer their own definition of economic efficiency on page 32: “maximizing} the economic surplus which is
represented geometrically by the portion of the area under the
market demand curve that lies above the cost marginal cost curve.”
This area is equivalent to the sum of two separate areas: the
consumer surplus (illustrated in Figure 2.2) and the producer
surplus (illustrated in Figure 2.3)
Another illustration of the economic surplus as market equilibrium
is shown in Figure 2.4 as the two areas A plus B
A market failure is defined as any market condition that prevents
the market from reaching the economically efficient position
A few of the market failures discussed in this course have been:
externalities, monopoly and public goods
Externalities (usually the existence of social costs not recognized
by either the seller or the buyer) often imposes costs on outsiders
that the market participants do not recognize when pursuing the
invisible hand to a market equilibrium: this market failure has
been studied extensively in this course
Other market failures have received less attention because they have
fewer environmental impacts
Public Goods
Dealing with one of these other market failures will be the topic of
this paper: specifically, public goods
Teitenberg and Lewis define public goods on page 30 as simultanCourse Syllabus. © Copyrights. IGlobal University. 2014. All Rights reserved. Rev. 12/29/2014
Page 1
eously being non-excludable and indivisible
By nonexcludable they mean the producer of the good can force its
users to pay for its production (think candy bars from grocery
stores: if the buyer shoplifts it, he/she will be thrown in jail)
By indivisible they mean one person’s consumption of it does not
diminish amounts available to anyone else (think watching a football game on television)
Goods that have both characteristics encourage people to be free
riders, that is, enjoy the good without paying for it
They don’t have to pay for it because the producer cannot force them
to (non-excludability)
They have no moral incentive to pay for the good because they know
their using it doesn’t deprive anyone else from having it indivisibility)
If a good has these characteristics, then markets cannot emerge
because producers can never sell it to make a profit
Some types of goods with these characteristics are extraordinarily
important to a society: national defense and environmental protection
We have seen in this course that environmental protection is nonexcludable because it is impossible to prevent persons from fishing
in common waters like the Atlantic Ocean or breathing clean air
Also, environmental protection is indivisible because my breathing
Clean air doesn’t appreciably reduce the volume of air available to
Others
These two factors: many public goods are important but cannot be
produced by private companies usually force governments to take
over their production [Note to students, not all “public” goods are
produced by governments such as the Dulles Toll Road that is indivisible when there is no congestion and was non-excludable until
tolls were installed, this road is now operated by a private firm
under contract to the State of Virginia]
USING COST-BENEFIT ANALYSIS TO FIND ECONOMICALLY EFFICIENT OUTCOMES
FOR PUBLIC GOODS
If markets cannot help us find economically efficient positions for
public goods, what should we do
We use economic techniques to approximate the benefits derived from
public goods and compare these benefits to the costs of production
Figure 3.1 illustrates how this might be done be contrasting beneFits derived from a public good with its costs
The costs of production of a public good are usually easily calculated as government agencies are adept at tracking what they
are spending so they can report to auditors like those of the
U. S. Government Accountability Office
Benefits that in order markets are measured simply as the amount
consumers are willing to pay for an item are far more difficult
in these situation
Tietenberg and Lewis devote an entire chapter (Four: Valuing the
Course Syllabus. © Copyrights. IGlobal University. 2014. All Rights reserved. Rev. 12/29/2014
Page 2
Environment: Methods)
In order to keep this paper within the five-page limit I shall not
say much about these methods here except to mention the most often
used one: contingent valuation
Succinctly contingent valuation is done by administering surveys to
users of public goods querying them about their personal valuations
of the good they are enjoying
Economist accustomed to analyzing quantitative data about actual
spending mistrust these survey valuations, but since decisions must
be made about how much national defense and environmental protection we need, we need some type of valuation estimates and something is better than nothing
With some estimates of benefits in hand, we can expect these benefits to decrease as more of the good is produced due to the familiar property of diminishing utility: in other words our estimated
benefit curve is likely to look quite similar to an ordinary demand
curve (the marginal benefits curve in Figure 3.1)
The marginal cost curve will have the same shape as a marginal cost
curve in an ordinary private market
Our goal then is to maximize net benefits which is done at the point
where marginal benefits just equal marginal costs (point R in Figure 3.1)
In practice, cost-benefit analysis is performed by identifying a
certain number of options for providing the public good, perhaps
size A small, B medium and C large
We can expect the estimated costs and benefits of A will be less
than those for B which will in turn be less for C
Our objective in doing cost-benefit analysis is to find the option
that maximizes net benefits and therefore social welfare
In the case of analyzing three alternatives, the best option would
be the one that has the largest net benefit, that is Bi-Ci
It should be noted here that many cost-benefit analyses endeavor to
maximize the benefit-cost ratio Bi/Ci, not the benefit cost difference; this is incorrect
For example, in the synthetic example just posed, the small option A
may have a high benefit-cost ratio because its costs are low but
still not deliver many net benefits
USING COST-EFFECTIVENESS ANALYSIS
T-L page 67
CONCLUSION
CBA is essential to making crucial decisions about providing public
goods
Its execution is far from “cut-and-dried” but federal government
economists are continually improving their techniques and
consequently improving public decisions about public good provision
In some cases where CBA techniques are not nearly accurate enough,
economists must settle for simply doing cost-effectiveness studies
Course Syllabus. © Copyrights. IGlobal University. 2014. All Rights reserved. Rev. 12/29/2014
Page 3
Environmental &
Natural Resource
Economics
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Environmental &
Natural Resource
Economics
9th Edition
Tom Tietenberg
Emeritus, Colby College
Lynne Lewis
Bates College
Boston Columbus Indianapolis New York San Francisco Upper Saddle River
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Library of Congress Cataloging-in-Publication Data
Tietenberg, Thomas H.
Environmental & natural resource economics / Tom Tietenberg, Lynne Lewis. — 9th ed.
p. cm.
ISBN-13: 978-0-13-139257-1 (alk. paper)
ISBN-10: 0-13-139257-3 (alk. paper)
1. Environmental economics. 2. Environmental policy. 3. Natural resources—
Government policy. 4. Raw materials—Government policy. I. Lewis, Lynne.
II. Title. III. Title: Environmental and natural resource economics.
HC79.E5T525 2011
333.7—dc23
2011017669
ISBN-10:
0-13-139257-3
ISBN-13: 987-0-13-139257-1
Contents in Brief
Preface
1 Visions of the Future
2 The Economic Approach: Property Rights, Externalities,
and Environmental Problems
3 Evaluating Trade-Offs: Benefit–Cost Analysis and Other
Decision-Making Metrics
4 Valuing the Environment: Methods
5 Dynamic Efficiency and Sustainable Development
6 Depletable Resource Allocation: The Role of Longer Time
Horizons, Substitutes, and Extraction Cost
7 Energy: The Transition from Depletable to Renewable Resources
8 Recyclable Resources: Minerals, Paper, Bottles, and E-Waste
9 Replenishable but Depletable Resources: Water
10 A Locationally Fixed, Multipurpose Resource: Land
11 Reproducible Private Property Resources: Agriculture
and Food Security
12 Storable, Renewable Resources: Forests
13 Common-Pool Resources: Fisheries and Other Commercially
Valuable Species
14 Economics of Pollution Control: An Overview
15 Stationary-Source Local and Regional Air Pollution
16 Climate Change
17 Mobile-Source Air Pollution
18 Water Pollution
19 Toxic Substances and Environmental Justice
20 The Quest for Sustainable Development
21 Population and Development
22 Visions of the Future Revisited
Answers to Self-Test Exercises
Glossary
Name Index
Subject Index
xxi
1
16
46
74
102
118
140
180
204
237
262
293
320
359
397
424
442
471
508
538
564
589
600
623
635
642
v
Contents
Preface
1
2
Visions of the Future
1
Introduction
The Self-Extinction Premise
EXAMPLE 1.1 Historical Examples of Societal Self-Extinction
Future Environmental Challenges
Climate Change
Water Accessibility
Meeting the Challenges
How Will Societies Respond?
The Role of Economics
DEBATE 1.1 Ecological Economics versus Environmental Economics
The Use of Models
EXAMPLE 1.2 Experimental Economics: Studying Human
Behavior in a Laboratory
The Road Ahead
The Issues
DEBATE 1.2 What Does the Future Hold?
An Overview of the Book
Summary 13 ? Discussion Questions 14 ? Self-Test Exercise 14
? Further Reading 14
1
1
2
3
3
4
5
6
6
7
8
The Economic Approach: Property Rights,
Externalities, and Environmental Problems
Introduction
The Human–Environment Relationship
The Environment as an Asset
The Economic Approach
EXAMPLE 2.1 Economic Impacts of Reducing Hazardous Pollutant
Emissions from Iron and Steel Foundries
vi
xxi
9
9
10
11
11
16
16
17
17
19
20
Contents
Environmental Problems and Economic Efficiency
Static Efficiency
Property Rights
Property Rights and Efficient Market Allocations
Efficient Property Rights Structures
Producer’s Surplus, Scarcity Rent, and Long-Run Competitive
Equilibrium
Externalities as a Source of Market Failure
The Concept Introduced
Types of Externalities
EXAMPLE 2.2 Shrimp Farming Externalities in Thailand
Improperly Designed Property Rights Systems
Other Property Rights Regimes
Public Goods
Imperfect Market Structures
EXAMPLE 2.3 Public Goods Privately Provided: The Nature Conservancy
Government Failure
DEBATE 2.1 How Should OPEC Price Its Oil?
The Pursuit of Efficiency
Private Resolution through Negotiation
The Courts: Property Rules and Liability Rules
Legislative and Executive Regulation
An Efficient Role for Government
Summary 43 ? Discussion Questions 43 ? Self-Test Exercises 44
? Further Reading 45
3
Evaluating Trade-Offs: Benefit–Cost Analysis
and Other Decision-Making Metrics
Introduction
Normative Criteria for Decision Making
Evaluating Predefined Options: Benefit–Cost Analysis
EXAMPLE 3.1 Valuing Ecological Services from Preserved Tropical Forests
Finding the Optimal Outcome
Relating Optimality to Efficiency
Comparing Benefits and Costs Across Time
Dynamic Efficiency
Applying the Concepts
Pollution Control
EXAMPLE 3.2 Does Reducing Pollution Make Economic Sense?
Evidence from the Clean Air Act
Preservation versus Development
EXAMPLE 3.3 Choosing between Preservation and Development in Australia
Issues in Benefit Estimation
20
20
22
22
23
24
25
25
26
27
28
28
31
33
34
35
36
38
38
39
41
42
46
46
46
46
48
48
50
52
53
54
54
54
56
57
57
vii
viii
Contents
4
Approaches to Cost Estimation
The Treatment of Risk
Distribution of Benefits and Costs
Choosing the Discount Rate
EXAMPLE 3.4 The Importance of the Discount Rate
Divergence of Social and Private Discount Rates
A Critical Appraisal
Cost-Effectiveness Analysis
EXAMPLE 3.5 NO2 Control in Chicago: An Example of
Cost-Effectiveness Analysis
Impact Analysis
Summary 69 ? Discussion Questions 70 ? Self-Test Exercises 71
? Further Reading 71
Appendix: The Simple Mathematics of Dynamic Efficiency
58
59
61
62
63
64
65
66
Valuing the Environment: Methods
74
Introduction
Why Value the Environment?
DEBATE 4.1 Should Humans Place an Economic Value
on the Environment?
Valuing Environmental Services: Pollination as an Example
EXAMPLE 4.1 Valuing Ecosystem Services: Pollination,
Food Security, and the Collapse of Honeybee Colonies
Valuation
Types of Values
EXAMPLE 4.2 Historical Example: Valuing the Northern Spotted Owl
Classifying Valuation Methods
Stated Preference Methods
DEBATE 4.1 Willingness to Pay versus Willingness to Accept: Why So
Different?
EXAMPLE 4.3 Leave No Behavioral Trace: Using the Contingent Valuation
Method to Measure Passive-Use Values
Revealed Preference Methods
Travel Cost Method
Hedonic Property Value and Hedonic Wage Methods
Averting Expenditures
Using Geographic Information Systems for
Economic Valuation
EXAMPLE 4.4 Valuing Damage from Groundwater Contamination Using
Averting Expenditures
EXAMPLE 4.5 Using GIS to Inform Hedonic Property Values:
Visualizing the Data
DEBATE 4.2 Is Valuing Human Life Immoral?
Summary: Nonmarket Valuation Today 98 ? Discussion Questions 99
? Self-Test Exercises 99 ? Further Reading 100
74
75
68
68
73
76
76
77
78
79
81
82
83
86
89
90
90
91
92
92
92
94
95
Contents
5
6
Dynamic Efficiency and Sustainable Development
102
Introduction
A Two-Period Model
Defining Intertemporal Fairness
Are Efficient Allocations Fair?
EXAMPLE 5.1 The Alaska Permanent Fund
Applying the Sustainability Criterion
EXAMPLE 5.2 Nauru: Weak Sustaina …
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