Question

Part A

1. Let’s say that you are indifferent between $1,000 today, and $5,000 in forty years. What is your implicit discount rate?

2. According to the Ramsey equation, what are the two components of the discount rate? (See Goodstein chapter 8).

3. What are the problems with using “willingness to pay” to value something?

4. Why might using “willingness to accept” give different valuations than “willingness to pay” would give?

5. Explain why the “efficient” level of pollution might depend on the initial assignment of Rights.

6. What are some reasons why Coasean bargaining might not lead to an “efficient” level of pollution? (150-300 words)

Answer 1

(1) Implicit discount rate is the existing discount rate in the payments inclusive of what you will get the payments. Implicit discount rate is calculated by

{[(Final amount you will get) / (the amount you have to forego now)]^n } - 1 * 100

where n is number of installment in which you will get payments

So here [(5000/1000)^1 - 1 ] * 100 = 400%

(2) Ramsey equation is r = ρ + θ g

Components of Discount rate are:

• The rate of pure time preference (describing impatience)
• The product of

(a) the consumption elasticity of marginal utility θ (describing how fast marginal consumption decreases in consumption)

(b)    the growth rate g (describing how fast consumption increases)

(3) Willingness to pay is the maximum amount a person is willing to pay for the product or lesser. The willingness to pay may depend upon person to person as one person is willing to pay for the good as it values them more while the other person is willing to pay less for the same product as it does not give them high utility to induce them to pay more prices. So the value of a good may not be find by the willingness to pay for that good.

(4) Willingness to accept is the minimum amount of money that a producer will accept when their production cost meets the amount while willingness to pay is the maximum amount of money or below at which the consumer is willing to buy a good. So willingness to accept have less value in most cases than willingness to pay.

(5) The Coase Theorem states that when conflicting property rights occur, bargaining between the parties involved will lead to an efficient outcome regardless of which party is ultimately awarded the property rights, as long as the transaction costs associated with bargaining are negligible. It also states that if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome. But efficiency comes when each party have equal access to the resource which sometimes is not possible. Assume the condition if factory which pollutes in an locality is given full permission to pollute, and people in that locality cannot do anything for this. This distribution of rights can never lead to efficient outcome. If factory is given permission to pollute upto a limited point and people can file a charge if pollution level rises, in this case both parties have some rights given, so this can leads to efficient outcome.

(6) The reasons of Coasean not reaching to efficient level is:

• First, Coasian bargaining does not eliminate the role of government in assigning initial property rights. This process will be subject to special interest group lobbying and rent seeking. In addition, because many environmental externalities are indirect, cumulative and uncertain. The legal system also involves some level of inefficiency.
• Second, Coasian markets comes from the fact that many environmental externalities, transport emission, noise pollution by cars or global effects such as climate change and ozone layer depletion which involve a large number of people. Bringing all the people together who destruct the resources and pollutes is difficult.