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Economics 3220 Lecture Notes - Social Discount Rate, Net Present Value, Opportunity Cost

Course Code
Economics 3220
Ali Kamar

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Chapter 6-2
CBA Framework
Step 4: Compare social costs and benefits of the program and calculate net
benefits as the difference between total benefits and total costs (NB= TB-TC)
o Total benefits are the total damage costs avoided (area under the MD
curve for the quantity reduced)
o Total costs are the total abatement costs incurred by polluting firms
(area under MAC curve for the quantity reduced)
o Decision rule: If MB>0 then project is viable, except the projection on
economic grounds
Class exercise
Suppose the government of Alberta proposed to reduce SOx emissions from
265 to 265 kilotonnes over a 20 year period
Estimates of costs and benefits of the proposed program are in the table.
Calculate the Net benefits to see if the program is economically viable
Not a good method
Compounding and Discounting
For many projects, benefits and costs occur in the future:
o Usually, costs occur in the near future
o Benefits occur in the distant future
However, decisions to accept or reject a project are made in the current time
(t=0) period
Since future benefits and costs are worthless in the current time period, we
need to find a way to calculate how much they are worth in the current time
this is called present value (PV) calculations
Discounting future benefits and costs is a way to calculate their present
values (PV)
It is the opposite of compounding or calculating future values (FV) of current
Suppose we have $100 today that we can invest in an interest bearing
account at an interest rate of r=5% per year
FV is received after 1 year=
o $100 (1+0.05)1 = $105 this is compounding
After 2 years = 105 (1+1.05)1 = 100(1+0.05)2
After 3 years = 100(1+0.05)3
If we used V0 to indicate value at present time (t=0_, then its
future value Vt received after t years is Vt=V0(1+r)t
Present Value of $105 received one year from now = $105/(1+0.05)1= $100
This is discounting
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