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# Chapter 6-2.docx

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University of Lethbridge

Economics

ECON 3220

Ali Kamar

Winter

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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
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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