Announcements
•
Problem set due this Thursday *in class* or electronically by email
before class.
•
Midterm exam is a week from Thursday. Study guide and practice
midterm are posted.
•
Midterm covers material through economic regulation.
•
Coffee hour next week (optional!!)
•
Mid-semester survey posted on Friday

Outline
•
Finish our discussion of DUM1.0
•
Summarize results from our in-class experiment
•
Conclude our theoretical overview of market failures
•
Theory of Economic Regulation
•
Application 1: Regulating a natural monopoly
Readings:
( VHV)
Economics of Regulation and Antitrust
Chapters 10, 11
. Available as a
free online resource through the UCB library (using a UCB IP address):
.

DUM 1.0
å
=
+
=
T
t
t
t
T
r
c
u
c
c
U
NPV
0
0
)
1
(
)
(
)
...
(
Key assumptions:
•
People are characterized by a
single discount rate
r.
•
They (act as if to) use this discount rate consistently over time– note there is
no
t
subscript on the r.
•
They (act as if they) use this discount rate consistently
across choice
situations and types of consumption.

•
The conventional Civic (option I) costs $16,000 and gets 30 miles per
gallon.
Simple DUM 1.0 application

Simple DUM 1.0 application
•
The Civic Hybrid (option 2) costs $20,000 gets 45 miles per gallon.

Simple DUM 1.0 application
•
Assume gas prices of $3/gallon.
•
Assume 15,000 miles per year
•
Assume you will sell the hybrid Honda Civic for $1000 at the end of 5 years.
•
Assume you will sell the conventionaI Honda Civic for $600 at the end of 5
years.
•
Assume a nominal discount rate of 10 percent.
•
Assume all costs are in nominal terms (discount nominal future values with
a nominal interest rate).
•
Assume we pay cash for the car in time period 0 and incur operating (fuel
costs) in time periods (years) 1 through 5.
•
Civic gets 30 mpg. Hybrid gets 45 mpg.

Policy implications?
•
Suppose that the government wants to incentivize the hybrid…(why
might it want to do this?)
•
One option would be to offer a rebate redeemable at the point of
sale.
•
If discount rate was 5% instead of 10%, would we need a larger or
smaller subsidy to get more people into cleaner cars?
•
Another option would be to tax gas!
•
What are we actually doing?

How does this compare to how you actually make these
trade offs between present/future costs/benefits?

DUM 1.0
•
Model assumes that people have stable preferences and a
stable discount rate.
•
Model can be used to calculate the overall utility associated
with options whose benefits and/or costs accrue over time and
predict choices.
•
If people actually made inter-temporal decisions consistent with
this model, the model would be very powerful.

DUM 1.0
•
DUM 1.0 is sometimes portrayed as rational choice behavior,
particularly by non-economists.

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- Spring '16
- Meredith Fowlie
- Economics