Unsolicited Life Lesson

1. Get organized!
 Unsolicited Life Lesson
2. Develop capacity to concentrate
 Excludability
• Excludable: a good for which it is possible to
exclude people who have not paid for it
• Non-excludable: a good for which it is not
possible to exclude people who have not paid
 Rivalry
• Rival: consumption by one consumer prevents
simultaneous consumption by another
• Nonrival: consumption by one person does not
diminish what is left for others to consume
Characteristics of economic goods

Nonrival Public good

(Vaccinations)

Private good Open access resource

(Slice of pizza) (Ocean fishery)
Rival

Excludable Nonexcludable
Video
 Elinor Ostrom
• Won the Nobel Prize in
Economics in 2010 for work
on managing open access
resources
– First woman to win the prize
– First non-economist to win it
• She flipped Hardin’s question
over
• Identified eight “design
principles” of stable, local,
common pool resource
management
 Ostrom’s design principles
1. Clearly defined boundaries
2. Rules regarding appropriation and provision adapted to local
conditions
3. Collective-choice arrangements that allow most resource
appropriators to participate in the decision-making process
4. Effective monitoring by monitors or accountable to the
appropriators
5. A scale of graduated sanctions for violators of community rules;
6. Mechanisms of conflict resolution that are cheap and of easy
access
7. Self-determination of the community recognized by higher-level
authorities
8. In the case of larger common-pool resources, organization in the
form of multiple layers of nested enterprises
 Questions
• Beyond understanding the source of pollution
problems (market failure), we have two other
big questions
– How much should we pollute?
– How should we implement a specific target?
• To think about these analytically, we need a
model
 A model of pollution control

• Basic trade-offs:
– Benefits: reduce damages from
environmental degradation
– Cost: commit resources with
opportunity cost for society
 Damages

All the negative impacts that

users of the environment
experience as a result of the
environmental degradation
Example
 Other effects
• Value of lost ecosystem services
– For example, mangroves shelter coastlines from
erosion and storm damage
• Value of lost biodiversity

We will discuss
valuation more in a
couple days
 Damage functions

• Two types:
– emission damage functions
– ambient damage functions
• Why might we need both?
 Damage functions
• Interpret the following examples:

• How to measure total damages?

Why might one damage function be
higher than another?

• # of people affected; e.g., urban

versus rural
• Time and circumstance: e.g., heat
inversion effect may depend on
seasonal weather patterns

• Other important considerations:

– Uncertainty: are damages typically
“known”
– Time
 Incorporating abatement costs into
general model of pollution abatement
• Starting with an emission damage function
graph, how can we include abatement costs
on the same graph?
• Why downward sloping?
• What is the meaning of the uncontrolled
emissions?
Abatement cost functions

1. MAC’s increase slowly at first

2. MAC’s increase rapidly from the start
3. Scale effect
What emission level of emissions is most
efficient in the pollution control model?

Why?
What happens to the efficient level when:

• Marginal damages increase?

• Abatement costs decrease
(perhaps because technological changes)
 Cost benefit analysis

• Public sector version of a profit and loss

statement—logic of maximizing net
payoffs applied to public sector projects
Video: Cost benefit analysis
 Basic idea
• Put everything into a common unit of account
(usually dollars since this reflects generalized
purchasing power)
• Then add together to get a simple number
reflecting the extent to which benefits outweigh
costs (or the extent to which they do not)

This does not mean that everyone is

better off, just that in aggregate
benefits outweigh costs
 Three obstacles to adding up

1. How to compare monetary expenditures on

policy with non-monetized damages to
human health and the environment?
(valuation)
2. How to compare net benefits this year with
net benefits 10 years from now? (time)
3. What to incorporate uncertainty?
 2. Time in cost benefit analysis

• How should we “add up” costs and benefits

that occur at different points in time?
– For example, how to compare policy costs
incurred today with environmental benefits that
occur ten years from now? 100 years from now?
 Time value of money
• What is worth more: $100 today or $100
received a year from now?
• Suppose the interest rate is 5% and you
put $100 in the bank today, how much will
you have in a year? Two years?
 Present value
• Suppose you put $613.90 in the bank
today and the interest rate is 5%. How
much will be in the account in 10 years?
• The present value is the value today of
money received in the future. What is the
present value of $1000 received in 10
years if the interest rate is 5%?
• What is the formula for the present
value?
Opportunity cost

• What discount rate?

– Return on next best
investment opportunity
• For example, real return on
capital (4% plausible) or
return on investment in
education/public health/etc.
 Example
• Suppose policy makers are choosing
between an investment in education that
has a rate of return of 5% and an
environmental policy that would reduce
environmental damages by $1000 in ten
years. Suppose the environmental policy
cost $800 today. Should we do it? Why?
• By this logic, the discount rate for public
policies should reflect the rate of return on
the next best investment—it could entail
education, national defense, or something
else