exam 2 review

resource economics

• nonrenewable vs. renewable– maximize pv of net benefit– renewable includes growth functions

• characterize efficient allocations

• compare to market allocations

• discuss policy to make market allocations more efficient

start with the price equation

• efficiency pricing:

Pt = MECt + MUCt

• where– MEC: Marginal Extraction Cost– MUC: Marginal User Cost

MUC and Q over time

• efficient MUC rises, reflecting increasing scarcity

• in response, Q extracted falls over time until reaching zero, when total MC = highest WTP (“choke price”) or reach backstop MC

• efficiency requires smooth transition to exhaustion of resource

constant MEC with no substitute

energy: efficient vs. market outcomes

vulnerability premium

energy: efficient vs. market outcomes

• surface water– how to allocate a renewable supply among

competing uses– intergenerational effects less important (future

supplies depend on natural phenomenon, e.g. rain, rather than current allocation)

• groundwater– withdrawing now affects future supply

water efficient allocations:surface vs. groundwater

efficient allocation: surface water

1. balance btw users• marginal net benefit equal across users

2. handle variability• above-average and below-average flows

must be accommodated

efficient allocation: groundwater

• if withdrawal > recharge, eventual exhaust resource

• MEC rises over time as water table falls

• pumping would stop:– no water left– MC pumping > benefit of water or MC of backstop resource

(desalination)

• price rises over time until choke price or switch point

utilities pricing: inverted block & seasonal rates

(potentially efficient)

• MAI = cumulative volume end of decade /

cumulative yrs of growth

• harvest when MAI maximized

forests: biological harvest rule

biological harvesting decision

economic harvesting rule

• harvest at age that maximizes PV of net benefits

1. planting costs• borne immediately• no discounting

2. harvesting costs• time of harvest• discounted

sample problem

Age Volume (cubic ft)11 70021 1,00031 3,000 when to harvest41 6,000 using biological rule?51 8,000 using economic rule?

Price: $2Planting cost: $1,000Harvest cost: $0.50Discount rate: 3%

optimal harvest age

• discounting shortens optimal harvest time– less tolerant of slow timber growth– comparing no harvest (increase in value of

timber) to harvest (sell and invest)

• high discount rates also destroy incentive to replant

fisheries: biological vs. economic harvest

• biology: “maximum sustainable yield” (MSY)

– yields maximum growth– largest catch that can be perpetually

sustained

• economics: maximize net benefit

too much effort! policy responses

• increase MC– require fishing farther from shore, use smaller nets, boats, or motors – but artificially increasing cost inefficient

• total allowable catch – restrictions on effort or size of catch – monitoring, enforcement difficult, also creates race to catch

• individual transferable quotas –quotas allocated, then trade– no race, allows most efficient fishers to buy rights from inefficient

fishers

sample problem

• Costs fisher $20 to fish salmon• Salmon sells for $10 • Harvest rate given X fishers is S = 30X-2X2

• How many people will go fishing, how many salmon will be caught, and what are total profits under– Open access– Limited entry (how many fishers should be allowed to

maximize profit?)