API 135/Econ 1661 Final Review

5/7/2011

Gabe ChanAvinash Kishore

Overview of reviews

Office hours Today: Right after the review session with Gabe Tomorrow: Room L130 with Liz and Max (3-5pm)

Material for review: Practice final (2009) posted on course website Other practice questions from previous exams This year final exam: Pre: Post Mid-term:: 2:1

Lecture notes are important More emphasis on the 2nd half (2:1). But remember big

concepts from pre mid-term. For 1st half: go over problem sets, practice mid-term

and the mid-term you took .

FINAL EXAM: 5/09 9:00am -12:00 pm 113 Sever Hall

Key Concepts from the 1st Half

Welfare economics Pareto and Kaldor-Hicks +ve net benefits is both a necessary and sufficient

condition for optimal policy: True/False? Why? Cost effectiveness:“designing fast trains to the wrong

station.” Explain what he meant (in economic terms).

Coase Theorem Are government policies are unnecessary to solve

environmental problems? Explain. Numerical problem

Welfare Analysis How discount rate affects NPV? Problems with B-C Ratio as a decision rule

Scale ignored Changing sign changes results

Cost side is relatively simpler: in practice and for exams

Benefit Estimation Why/when do we need stated preference methods? You should be able to explain each method in 1-2

sentences and know the situations when it is best applied. Questions often have >1 parts. Read carefully and answer all

Benefit Estimation

Travel Cost Method Rework problem set 1—all parts. What are main limitations of the method?

Limited applicability, confounds

Hedonic Price/Hedonic Wage Method Does VSL provide an economic estimate of the value of a

human life? Explain. identify two concerns with using marginal implicit prices

from hedonic wage studies for calculations of VSL

Great summary on Page 11 of Lecture 8 of all methods

Natural Resource Economics Hotelling

Rework Problem Set 2, Mid-term and the Sample mid-term

Time rate of change of the marginal user cost of a NR resource. Intuitively, why does this relationship hold?

For a typical nonrenewable resource, would you expect the rate of extraction to increase, be constant, or decrease over time? Why?

Conditions under which HR is not observed in reality?

For quick check: See page 10 of Lecture 9-10 (spl. Points 8-12). Can you answer them all?

Economics of the Fishery: Know Diagrams and how to draw them

Determining effort levelTotal cost with regulation

Break

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Cost effectiveness analysis: policies for pollution control

What’s the difference between efficiency and cost-effectiveness? Same fast train, different station

Pollutants vary in how “mixed” they are (local, regional, global), and how long they “live” (flow, stock, in between)

Know how to show that equalizing MC across sources achieves cost effective allocation. (L 13-15, p 9)

Why is this important? heterogeneous MACs Full list of policy options (L 13-15, p 2) Full list of criteria (L 13-15, p 8)

Standards

How do they work? Know how to analyze graphically Performance of command and control approaches Types of standards-based policies

Technology standards Performance standards Ambient standards Non-uniform standards (cost-effective?) Vintage differentiated standards

Incentives for technological change?

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Pollution Taxes

How do they work? Know how to analyze graphically & how to

determine the tax that will achieve a given target. Know how to model incentives for tech change Political feasibility? (the “T” word)

Incentives for tech change

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Tradeable permits How do they work? Know how to analyze graphically and how to determine the

equilibrium allocation. Issues with CAT

Point of regulation (upstream, downstream) Allocation – free or auction Cost containment mechanisms Responsiveness to growth, inflation, tech change

The independence property of permit allocation (Coase): The final distribution of emissions and the final marginal

abatement cost incurred by firms is independent of initial allocation of permits (under usual conditions: no transaction costs)

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Policy instrument comparisons

Uncertainty: relative slopes rule (Weitzman) What happens when MB and MC are uncertain

and correlated? Know the graphs and know the results

Taxes vs. Tradable Permits See L13-15 pg 21-22

Applications: lessons from CAA and Acid Rain control What was the nature of the problem? How did firms comply?

Climate Policy

Policy Instruments for GHG Control

Voluntary agreements (e.g. USCAP)These already exist; environmental impact is close to zero

Command-and-control regulation (e.g. energy efficiency standards, CAFE standards)Not cost-effective, requires extensive information, behavioral advantages?

Carbon taxesCost-effective, but politically challenging

Cap-and-trade systems (e.g. EU ETS)Also cost-effective, politically more feasible?

Hybrid systems (essentially a cap-and-trade system with additional permits if the price crosses a lower or upper threshold)Has features of a tax and a cap-and-trade system

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Key Concepts

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Science GHG emission sources, atmospheric mixing and lifetime uncertainty, distribution of impacts

International Climate Policy 3 policy architecture classes baseline years linkage, CDM (emission reduction credits) UNFCCC country groupings, free-rider problem trade & the environment (good/bad matrix), leakage, border

adjustment tariffs National Climate Policy

general approaches (tax, C&T, command & control, standards) cost containment (banking/borrowing, price ceiling/floor, offsets) technological change distributional equity (allocation and independence principal) upstream vs. downstream, economy-wide vs. sectoral

Sub-national Climate Policy preemption, negative/benign/positive interactions with nat’l policy leakage

Substantive Knowledge Science

general understanding of the greenhouse effect, uniformly globally mixed, long atmospheric lifetimes, several important GHGs

International Climate Policy UNFCCC Kyoto Protocol (too little, too fast, why?) COPs: Copenhagen, Cancun, (Durban) WTO alternative venues (G-20, MEFs, etc.) CDM

National Climate Policy Waxman-Markey, (Collins-Cantwell) EPA vs. MA and endangerment

Sub-national Climate Policy CA AB32, (Western Climate Initiative) RGGI

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Models to know(Partial list)

Externalities and the efficient level of production Socially efficient level of pollution control Travel cost Hedonic wages and property values Dynamic efficiency: non-renewables (2 period) Fisheries Cost effectiveness (2 firms; tradeable permits &

taxes) Technological change and instrument choice Weitzman rule

Backup

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6. Climate change

Nature of the policy challenge Toolkit of incentive-based instruments Challenges associated with achieving

international cost effectiveness. Economic assessment of the Kyoto Protocol. Elements of Stavins’ proposed architecture

Emissions tax Cap and Trade Hybrid

Price instrument Greater certainty re marginal cost May be below or above policy target for quantity Compensate through revenue but leave distribution up to politicians Politics: don’t need to distribute allowances, easier to explain Admin: firms are used to taxes, less so to trading

Quantity instrument, emissions are fixed Price volatility Easier to harmonize with other systems Compensate through allowances and/or revenues, discretion in allowance allocation. Can reproduce the benefits of the tax approach Politics: alternative to aversion to taxes History of successful CAT systems

Most advantages of CAT but limits price volatility and cost-side uncertainty But no upper limit on aggregate emissions Liked by business but harder sell to environmentalists and EU

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Major topics from the course

1. Economic causes of environmental problems2. Cost effectiveness & efficiency3. Efficiency analysis: benefits & costs4. Natural resources5. Cost effectiveness analysis: policies for

pollution control6. Climate Change7. Trade and the Environment

7. Is trade good or bad for the environment?

Environmental effects of trade

via growth in income:

for a given level of income :

Harmful effects

larger scale of economic activity

“Race to the bottom” in national regulation

Beneficial effects

shifts to cleaner techniques and composition of economic activity

“Gains from trade”: ratcheting up standards, consumer power, innovation…

7. Is trade good or bad for the environment?

Environmental effects of trade

via growth in income:

for a given level of income :

For SO2 Yes, pollution decreases after $5,700 p.c. via regulation

Yes, favorable effect dominates

For CO2 No evidence of reduced emissions with growth

Trade may increase emissions

Explanation: global externality, lack of a comprehensive global climate agreement

7. Trade and the Environment

Do the WTO & environment conflict? How can globalization best be harnessed?