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ECON 3220 (17)
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Chapter 6-2.docx

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University of Lethbridge
ECON 3220
Ali Kamar

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 investments Discounting  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= 1 o $100 (1+0.05) = $105 this is compounding  After 2 years = 105 (1+1.05) = 100(1+0.05) 2  After 3 years = 100(1+0.05) 3  If we used V0to indicate value at present time (t=0_, then its t future value Vtreceived after t years is Vt=V0(1+r)  Present Value of $105 received one year from now = $105/(1+0.05) = $1001 This is discounting o If V it the future value received t years from now, then its present value V 0 V /t1+r) this is discounting o In this contest, r is called the discount rate  We can use this discounting formula V = V / (1+r) to calculate net present 0 t value of an enironemtnal policy of program when beenfits and costs occur in the future  Definition: The process of calculating value of a future stream of benefits or costs is called discounting and the interest rate used to calculate the present value is called the discount rate Net present value (NPV) formula t  Following the discounting formula V = V0/(1tr) o Where V = p0esent value (or value at current year t=0) o V –tfuture value after t years o r= discount rate we can write the NPV formula as 1 2 3 o NPV= NB + (N0/ (1+r) )+(NB /(1+r) 2 +( NB /(1+r) )3……  So to apply this formula, we need to, o Calculate NBs for each time period (using NB=TB-TC) o Ca
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