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UW-Madison AFROAMER 343 - lecture 15 aae 343 spring 2013 for students

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Topics Today (3/12/13)  Intro to Benefit-Cost (Cost-Benefit) Analysis (BCA)  Example: The SO2 Allowance Program  Discounting  Exams returned in discussion section this weekBCA Intro  Benefit-Cost Analysis – a comparison of total social benefits and total social costs associated with alternative policies.  Net Social Benefits = Total Social Benefits – Total Social Costs.  BCA involves computing net benefits for each policy alternative.  While BCA provides useful information, economists do not argue that society should simply select the alternative with the greatest social net benefits.  In particular, there are distributional impacts at stakeBenefit-Cost Analysis Intro  BCA and efficiency  Until now in the class, the efficient allocation has been determined by the intersection of marginal curves (such as MC=MB, or MAC=MD)  But there are many environmentally-relevant decisions that are typically defined by several discrete alternatives:  Build a dam (or remove an existing dam) or not  Adopt a particular policy to reduce CO2 emissions  Adopt a particular energy efficiency program  Cut a particular old growth timber stand  Some of these are naturally discrete, some are discrete by the policy process BCA and Efficiency, Con’t  In the case where the decision problem involves only two or several alternatives, BCA determines the efficient allocation: choose the alternative that maximizes social net benefits  Maximizing social net benefits does not imply that everyone is better off –recall the “pies” from lecture #5 –it means that everyone could be made better off  Kaldor-Hicks efficiency criterion, pg. 69 of the text –”Potential Pareto Criterion”  This is the main reason that economists do not argue that all policy decisions should be based only on BCA Benefit-Cost Analysis IntroLike it or not, in public policy BCA is here to stay  It is now in many statutes concerning environmental policy  A watershed: Executive Order 12291, issued in 1981 after President Reagan took office.  Federal agencies ordered to prepare economic analyses that to the extent practicable calculate benefits and costs of major rules on a comparable monetized footing.  Agencies should promulgate regulations only if benefits "outweigh" costs, unless this explicit and quantitative balancing was precluded by the underlying statute.  Endangered Species Act is the only statute involving environmental policy that explicitly forbids the use of BCA Opportunity Cost  In economics, the true measure of the cost of scarce resources in economic analysis is their “opportunity cost”: their value in their best alternative use  Usually at the margin this cost is appropriately measured by price  Sometimes OC can be easy to omit or neglect in an economic analysis (BCA or other analysis)  Example from midterm 1: what is the opportunity cost of the 5th unit of water used by farmer 1? Benefit-Cost Analysis Intro A=0 B=1 C=5 D=10 E=NIWA. Identify project alternatives (one of which is baseline) B. Identify scenario alternatives a. What will happen under each alternative? C. Enumerate (identify and list) the benefits and costs D. Quantify as many benefits and costs as possible/necessary It can be the case that you do not need to monetize all benefits and costs to see a clear distinction E. Sensitivity analysis F. Identify the distribution of benefits and costs G. Conclusion… BCA: Basic ApproachCBA Example: Lead Phaseout Program From Farrow and Toman, RFF discussion paper 99-11, 1998Lead and Crime  Very high correlation over time  “Lead emissions from automobiles explain 90 percent of the variation in violent crime in America. Toddlers who ingested high levels of lead in the ’40s and ’50s really were more likely to become violent criminals in the ’60s, ’70s, and ’80s.  Correlation holds true with no exceptions  Across countries, across states, even across neighborhoods  Neuroscience supports the data  Not only does lead degrade cognitive abilities and lower intelligence, it also degrades a person’s ability to make decisions by damaging areas of the brain responsible for “emotional regulation, impulse control, attention, verbal reasoning, and mental flexibility.” http://www.motherjones.com/environment/2013/01/lead-crime-link-gasoline http://www.forbes.com/sites/alexknapp/2013/01/03/how-lead-caused-americas-violent-crime-epidemic/Benefit cost analysis and environmental polkicy  My informal review of benefit cost studies of environmental policies to reduce pollution/toxins indicates that costs tend to be overstated and benefits tend to be understated.  Tendency to understate the value of technological change in reducing costs  Technological change has no political favorites!  Health benefits of reduced pollution/toxins tend to be higher than expected. We’ve talked a lot about this program, but we have not discussed whether benefits of the program exceeded the costs.  This example illustrates:  The role of nonmarket valuation (including VSL)  Establishment of the counterfactual in ex-post CBA  The high degree of uncertainty in CBA analyses  Evidence that the estimates of the costs of regulatory programs are often initially overstated  In this case, the benefits of the program were initially understated  Yet even a rough analysis can prove illuminating CBA Example: EPA’s Acid Rain Program *From Chestnut and Mills, Journal of Environmental Economics and Management 2005 Identify project alternatives Title IV of the 1990 CAAA enacted vs. counter-factual” (the world without it)  Enumerate benefits and costs  Costs: abatement costs to firms  Benefits:  Health benefits  Environmental benefits CBA Example: EPA’s Acid Rain ProgramCBA Example: EPA’s Acid Rain Program  Costs:  Lower than predicted due to flexibility for technological innovationCBA Example: EPA’s Acid Rain Program  Statement in the paper about the counterfactual:CBA Example: EPA’s Acid Rain Program  Why the counterfactual has an emissions level similar to 1980:CBA Example: EPA’s Acid Rain Program  Benefits:CBA Example: EPA’s Acid Rain Program  Benefits:CBA Example: EPA’s Acid Rain Program  Benefits:CBA Example: EPA’s Acid Rain Program  Benefits:CBA Example: EPA’s Acid Rain Program  Results:CBA Example: EPA’s


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UW-Madison AFROAMER 343 - lecture 15 aae 343 spring 2013 for students

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