IE496 Industrial Engineering Internship Dr. Barnes March 17, 2008 Lecture # 8.
Lecture 17 March
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Transcript of Lecture 17 March
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Public Goods, Externalities andResources Valuation
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Public Goods are goods for which
exclusion is impossible. One example is National Defense: A
military that defends one citizen
from invasion does so for the entire
public.
Public Goods
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Characteristics of Public Goods Nonexclusion: The inability of a seller to
prevent people from consuming a good if
they do not pay for it.
Nonrivalry: The characteristic that if one
person consumes a good, another personspleasure is not diminished, nor is another
person prevented from consuming it.
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Externalities Externalities are costs or benefits of
market transactions not reflected in
prices.
Negative externalities are costs to third
parties.
Positive externalities are benefits to thirdparties .
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Externalities and Efficiency
The marginal external cost is the
dollar value of the cost to third
parties from the production orconsumption of an additional unit
of a good. These occur when
market transactions for a goodproduce negative externalities.
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Positive externalities The marginal external benefit is
the dollar value of the benefit tothird parties from an additional unit
of production or consumption of a
good. These occur when themarket for a good creates positive
externalities.
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Internalization of Externalities
An externality can be
internalized under policiesthat force market
participants to account for
the costs of benefits of their
actions.
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Property Rights and Internalization
of Externalities
Externalities arise because some resource
users property rights are not considered in
the marketplace by buyers or sellers of
products.
Governments can give businesses the right
to emit wastes in the air and water or it cangive individuals the right to clean air and
water.
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Recycling Recycling may be a less efficient and more
polluting use of labor, land and capital than
simple land fill disposal because: Collecting waste for recycling costs three
times as much as collecting it for disposal.
Rural land is inexpensive.
Recycling paper creates more water pollutionand does not save trees; it simply reducesthe number that are planted.
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Regulatory Solutions
Instead of using market
forces to force firms tointernalize externalities, we
can use emission standards
and apply these to all
market players.
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Global Externalities
CFCs
Deforestation
Global Warming
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Cost Benefit Analysis Net present value (NPV)
Internal rate of return (IRR)
Net benefit investment ratio (NBIR)
Domestic resource cost ratio (DRCR)
Benefit cost ratio (BCR)
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NPV
NPV =
How to decide the appropriate discount rate
to be used in the FA?
n
t
t
tt
r
CB
0 1
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IRR (2) Calculate IRR on the residual cash flow=>
if > TRR, then accept the larger project
Advantages:
Not directly rely on the selection ofdisct rate
Commonly used in commercial field
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IRR (3) Disadvantages:
Need to hv at least one -ve cash flow period
to make the NPV=0
Not unique
Cant be used to rank a group of independent
projects whose IRR > TRR if there is a singleperiod budget constraint
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NBIR (1) Def.: Ratio of the PV of the projects
benefits, net of operating costs, to the PV
of its investment costs
NBIR =
n
t
t
t
n
t
t
tt
r
IC
r
OCB
00 )1()1(
)(
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NBIR (2) NBIR shows the value of the projs
discted benefits, net of OC, per unit of
invt
NBIR > 1 => accept Advantage: correct criterion to use if there
is a single period budget constraint
Disadvantages Not suitable for mutually exclusive projects
Difficult to hv consistent conventions in
allocating certain costs between IC and OC
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DRCR (1) Ratio of PV of the projects net domestic
resource costs to PV of theprojects net FX
earnings
DRCR:
)($)1(
)()($)1()(
0
USrCBL
rBC t
tftf
n
tttltl
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DRCR (2) DRCR < = OER => The project shouldproceed if it uses less domestic resources,
measured in local prices, to earn a unit of
FX than is the norm for the whole
economy.
Adv.: avoid (postpone if EA) the need to
specify a shadow exchange rate in advance
Disadv.:
Cant be use for single period BC and
mutually exclusive projects if both
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BCR (1) Ratio of the sum of the projects disct
benefits to the sum of its discted
investment and OCs
BCR :
t
tn
tt
t
r
C
r
B
)1()1(0
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BCR (2) If BCR> =1(disctedbenefit>discted costs)
Adv.: Easy to show the impact of a % D in
costs/benefits on theprojects viability
Disadv.:
Cant be used for mutually exclusive projects and
single period budget constraint
Need to adhere to conventions regarding the
designation of expenditures as costs & benefits