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First Welfare Theorem

If private marginal benefits (PMB) are equal to social marginal benefits (SMB) and private marginal costs (PMC) are equal to social marginal costs (SMC), social welfare is maximized at the competitive market price and quantity.


occurs when the consumption or production of a good imposes costs on society that are not borne in full by the consumer or producer. In essence, the market is producing too much. (raise price to restrict quantity) These are called external costs/damanges- per unit external costs= marg external damages

Public Good

are thought of as goods with positive externalities. Non- rival (costless to share, MC of another user = 0) and non- excludable (consumption imposes external costs because there's less of it for everyone)

Excludable and Rival Goods

Private Goods and Non-renewable resources

Excludable and Non- Rival Goods

Natural Monopolies: Landfills and powerplants

Non-Excludable and Rival Goods

Common Pool: Fish in the ocean, clean air, congested highway

Non-Excludable and Non-Rival Goods

Pure Public Goods: National Defense, Tornado Siren, Infinite Park/Highway

Market Failure

main problem with public/common pool goods because some of the benefits of the good go to others, therefore, PMB dont = SMB. This is because exclusion is not feasible. Examples, technology spillover, market power, asymmetric information.

Coase Theorem

A way to fix externality problems without a government solution, instead people can bargain
1. property rights well-defined and tradable- set of valid claims to a good or resource that permits its use and the agent has the right to trade the valid claims. Without monitoring, property rights are not enforceable
2. Exclusion:no one who benefits/loses is outside the bargain
3. low transaction costs: hard to get everyone together so if numbers are small, transaction costs usually are low. Larger number = higher transaction cost because of free riders

Main Idea: when conditions hold, bargainers internalize all of the costs/benefits.

Bargaining can work for commons used by neighbors and oil in a common pool shared by adjoining leases

When Polluters have property rights...

Victims pay to reduce the externality. Victim is willing to pay on the margin to reduce pollution by the amount equal to MED and polluter is willing to accept payment equal lost profits= PMB-PMC

When Victims have property rights...

Polluters pay for the right to increase the externality. How at most? Profit to be gained by next unit production: PMB-PMC and victim is willing to accept payment equal to being compensated for damages (MED).

Rational Ignorance

is ignorance of voter issues or opportunities to vote that arises due to voter opportunity costs.
-median voter theorem: the middle voter wins

Rent Seeking

active shaping of policy by firms to increase profits by lobbying. Industries and large numbers of individuals organize to make these investments. Those who stand to gain or lose most rationally invest more in the outcome. That is why politics are corrupt because they have to pay attention to constituents that have money.

Disadvantages of Markets

external costs or benefits lead to an over/under production of externality/public good (free riding). Common will be over- consumed

Disadvantages of Government

-Rational ignorance on costs/benefits of policy, political stances, and shortsightedness. -Special interests may focus Gov on narrow policies/shape policy to own benefit.
-Info monopolies create inefficiencies`

Policy in Four Dimensions

1. Efficiency- does this policy get the market to P and Q
2. Incentives to improve in LR- P and Q might change overtime. Does the policy encourage agents to change with it?
3. Administrative and Enforcement costs- how expensive is it to implement the policy
4. Equity: fairness, how does this policy affect households as a function of their income?

Liability Law

policy via threat of lawsuit

Strict Liability

Injurer must always recompense victim for injury if guilty.
1. achieves efficient precaution in ideal setting
2. injurer pays
3. information costs are borne by risk-takers- low administrations costs are low
4. Good long-run incentives because as technology changes costs and benefits of precaution, risk taker adjusts


injurer pays only if they failed to take a specified level of precaution, if injury occurs in spite of precaution, no damages awarded. So, injurer gets benefit of risks w/o paying all costs.
1. achieves efficient precaution
2. injurer does not always pay
3. information costs borne by legislation. Low admin costs
4. poor long- run incentives- risk takers only need to meet the standard.

Joint and Several Liability

1.Allows suit to be brought against any party involved in firm decisions, including lenders.
2.Any party who assumes responsibility for polluted land even if they do not contribute to the pollution

Suit may be brought separately or jointly.

Increases efficiency in the face of Judgment proof because it gives an incentive for original risk takers to weigh longer run consequences of their actions. The more the costs of risk are internalized, the better job liability does as policy.

Judgment Proof

a risk taker who would go bankrupt before being able to pay damages in the event of an accident

Command and Control

policies set a standard and enforce it via fines, compulsory shutdown, etc.

-straightforward policies
-appear fair
-low admin and enforcement costs

-Not SR efficient-one size does not fit all, for performance standards you have at least cost efficiency
-No LR incentives for improvement except for cost efficiency when dealing with performance standards.

Quotas/Rationing (C & C)

-Limit all parties to same quantity
-resource or clean up shared equally
- fixes quantity that seems equitable
-simple allocation= low admin and enforcement costs

- No incentive to become more cost efficient in LR, only allowed to up to the quota
-Not efficient in SR, no guarantee that each party will use rationed amount equally well/ at lowest MC. Ex. some people are good at fishing and others are not

Technology Standards

regulation that calls for a specific technology to be used or not used.
1. Usually not cost efficient in SR b/c one size does not fit all
2. No incentives to improve in the LR, incentive change when standard changes
3. Admin and Enforcement costs are low
4. Equity not fair to hold everyone to the same standard because some might pay more than others


the reduction of an externality.
MCA- cost of cleaning up the next unit of pollution, supply curve
MBA- benefit to society from cleaning up next unit, demand curve- first units very valuable, later units less or equally so.

Performance Standards

defines a limit to some measurable quantity and allows agents to determine how they will meet that limit
1. low admin and enforcement costs
2. cost efficient in SR: flexibility b/c individuals have information that they can use to meet standard at lowest cost
3. LR cost efficiency: incentives for innovation
4. Equity, standard could be set to reflect differences between agents

1.Not SR efficient- cost efficiency means that the performance standards achieve their goal at lowest cost but may have perverse effects like 50 mpg, you may pollute more because you can drive for longer
2.Not LR efficient, standards do not move over time

Environmental Tax

is a charge levied against an externality.
-socially efficient outcome, tax charges for MED at optimal quantity q*

-SR efficient because agents internalize cost of actions
-LR incentives for less pollution/better use of a common pool because agents want to avoid taxes
-significant administration and enforcement costs because requires monitoring externality
-equity: likely to affect household with different income levels

Tradable Permits

property right to some quantity of externality/ common pool.
Abatement is expensive, so firms trade permits until MC of abatement are equal.

-SR efficient: gets P,Q because agents internalize cost of actions
-LR incentives for less pollution/better use of a common pool because agents want to avoid permit costs
-Equity:auctioning raises rev for gov't and giving out permits raises revenue for permit holders

-high admin and enforcement costs for exchanging of permits and monitoring pollution
-prop. rights are valuable--rent seeking and too many permits would equal no improvement

Elasticity Incidence

Between Supply and Demand, the less elastic side or more inelastic side pays more because they have a lesser ability to adjust
1. (q2-q1)/(p2-p1)
solve for Q first and multiply (P/Q) by the the coefficient (A) in front of P.

Perfectly Inelastic demand

elasticity of demand is zero, function is a vertical line
quantity never changes
*since elasticity is zero it is clear that the consumer will pay policy costs

Perfectly Elastic demand

elasticity is infinite
function is horizontal line
price never changes
*producer/supply side of the market will pay for the policy costs

Perfectly Inelastic Supply

The supplier pays the costs of the policy

Compliance Costs

tax (Q-Qc)/2
similar to DW loss but different because we are assuming our tax is reducing an externality

Price paid by consumers

is Price or Pc

Price received by producers?


Consumers Pay?

(Price Paid- Price no tax)*
(Q no tax- Qtax)/2

Producers Pay

(Pno tax- Preceived)*
(Qno tax- Qtax)/2


price paid- price received

Damage Avoided

count profit losses, bodies, sick days.
-def: estimates environmental benefits by looking at reduction in well defined social costs.
Frequently used to measure benefits of clean water and air

not everything of value has a well defined price

Hedonic Pricing Method

Some market goods (real estate) have values based on enviro quality
separate out enviro piece in its price
DEF: uses large data sets on real estate price to estimate environmental amenity values

revealed preferences and real estate data are available

environ attribute must be tied to real estate, assumes complete information, doesnt capture value of unsold homes, joint products

Travel cost method

construct a demand curve based how much people are willing to pay to visit that particular site.
DEF: uses expenditures to value recreational sites so it requires data on expenditures of visitors-survey.

revealed preference and easy to do

-Doesnt count opportunity cost or option value (how people value it that have not been to the site)
-poor measure for locals
-values distance instead of amenities

Contingent Valuation

Survey- used when value cannot be generated by a revealed preference method.

captures both use and non-use values (same as option value)

Difference between what people say and what they would actually do
stated preference- they can say whatever they want without being accountable and sometimes people may include the value of a good for others as well, which leads to double counting- this is known as warm glow
-survey design flaws

Revealed Preference

methods estimate values based on what people actually spend. It eliminates the discrepancy between what people say they will pay and what they actually pay

Stated Preference

they can say whatever they want without being accountable

Warm Glow

sometimes people may include the value of a good for others as well, which leads to double counting

Profit for resource owner (Basic Nonrenewable resource model)


No benefit to leaving resources behind
S, Xo, X1

xo enters as negative because extraction today as an opportunity cost because it reduces whats there for next year. Stock minus initial extraction leaves you with x1.


means adjusting the value of a future benefit to account for the opportunity cost of waiting to receive that benefit

Static costs

current extraction costs

dynamic costs

opportunity costs

The price of oil today is $83.24/bbl (for West
Texas Intermediate). The real rate of interest is
about 3%. The forecast price for oil next year
(based on the one-year futures contract for oil)
is $85.40. MC are 0

P1-MC(X1)/Po-MC(Xo)= 1+r
(just rewritten)

x=83.24*1.03= 85.74

so the basic resource model gives an approximate answer.


investment into an existing reserve that increases the quantity extracted. Ex, injecting gas into an old well, creating a new mine shaft

The Box:
Top left= Current reserves
Bottom left= Development
Top right= exploration
Bottom right= exploration and development

implies MC rise as resource drawn out, so does not change basic resource model


looking for new deposits to transform into reserves

The box:
Top left: Current reserves
Bottom left: development
Top Right: exploration
Bottom right: exploration and development

search for new reserves so it changes results in the early phase of the model when exploration has low costs, reserves grow and prices may fall. exploration high costs, reserves dwindling and prices may rise.

Discount rate and policy?

Higher discount rates make immediate action look more costly relative to benefits. Because the costs today will be worth the same relative to benefits.

Base Load

long term contracts for energy at levels that demand never falls below
cant be met by intermittent sources
supplied by coal, nuclear, hydro, and some geothermal

Spinning reserves

power stations paid to be running to meet excess demand
also cant be met by intermittent sources

Spot market

day ahead contracts
intermittent energy sources (renewable) can only sell here

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