COSTBENEFIT1

COSTBENEFIT1 - FRONT COVER VALUATION ICOST ­BENEFIT...

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Unformatted text preview: FRONT COVER VALUATION ICOST ­BENEFIT ANALYSIS TRADE POLICIES AND RESTRICTIONS N PRIMARY MARKETS COST ­BENEFIT VALUATION IN PRIMARY MARKETS by amses rmendariz by Ramses Armendariz COST ­BENEFIT ANALYSIS INTERNATIONAL TRADE SUMMER 2011 FALL 2011 UNIVERSITY OF MINNESOTA GOAL OF THIS CHAPTER VALUATION IN PRIMARY MARKETS OBJECTIVE OF THIS CHAPTER Compute costs and benefits in primary markets. DEFINITION OF PRIMARY MARKET Market that is directly affected by a project. – Market of output provided by the project – Markets of inputs employed to develop the project COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS TYPE 1 OF OUTPUT MARKETS EFFICIENT MARKETS COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS DEFINITIONS OF EFFICIENT MARKET 1) Market in which Total Surplus (TS) is maximized. TS = CS + PS + GR 2) Market in which Net Benefit (NB) is maximized. NB = Gross Benefit – Gross Cost COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS AGGREGATE (MARKET) DEMAND – – – – Each demander is a price taker. No price discrimina\on across aggregated demanders. The good is rival in consump\on. Complete Markets (No markets are missing). The inverse Aggregate Demand is a) The (social) Willingness To Pay (WTP). b) The Social Marginal Benefit (SMB). c) The Private Marginal Benefit (PMB). COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS AGGREGATE (MARKET) DEMAND – Gross Benefit derived from consuming λ more units. GROSS BENEFIT WTP(Q0) WTP(Q0+λ) PD(Q) = SMB(Q) Q0 COST ­BENEFIT ANALYSIS Q0+λ FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS AGGREGATE (MARKET) SUPPLY – – – – Each supplier is a price taker. No arbitrage condi\on. The good is excludable. Complete Markets. The inverse Aggregate Supply is a) The Social Marginal Cost (SMC). b) The Private Marginal Cost (PMC). COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS AGGREGATE (MARKET) SUPPLY – Gross Cost derived from producing λ more units. PS(Q) = SMC(Q) SMC(Q0) GROSS VARIABLE COST SMC(Q0+λ) Q0 COST ­BENEFIT ANALYSIS Q0+λ FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS 3 GOV’T POLICIES THAT AFFECT PRIMARY MARKETS 1) By injec\ng λ units directly into the economy. a) Through a market opera\on – λ is so small that the price is not affected. – λ is so large that the price is affected. b) Through a nonmarket opera\on – Very HARD to compute costs and benefits. 2) By affec\ng the cost of suppliers. 3) By affec\ng the benefit derived by demanders. COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS GOV’T SUPPLIES A SMALL QUANTITY λ MARKET S GOV’T AS A PRICE TAKER GR P* MR D Q* λ " GR is the Net Benefit derived from the project! COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS GOV’T SUPPLIES A LARGE QUANTITY λ GROSS BENEFIT S Less Produc\on P* Pλ More Consump\on D QS Q* QD λ COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS GOV’T SUPPLIES A LARGE QUANTITY λ NET TRANSFER S Cost to Consumers Benefit due to GR Pλ D QD QS λ COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS GOV’T SUPPLIES A LARGE QUANTITY λ NET BENEFIT IN PRIMARY MARKET S NOTE: This Cost ­Benefit Analysis does not include the cost of obtaining λ! – The value of the inputs used. D The book refers to this as Gross Benefit. QD QS λ COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS PROJECT DECREASES THE COST OF PRODUCTION NOTE: GROSS BENEFIT S The cost decreases because the project changes the technology employed! S’ Less Produc\on with old technology. D Higher Consump\on P* Q* Q’ COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS PROJECT DECREASES THE COST OF PRODUCTION GROSS COSTS S S’ More Produc\on with new technology. D Q’ COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EFFICIENT MARKETS VALUATION IN PRIMARY MARKETS PROJECT DECREASES THE COST OF PRODUCTION NET BENEFITS S S’ P’ D Q’ COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA MONOPOLY VALUATION IN PRIMARY MARKETS TYPE 2 OF OUTPUT MARKETS MONOPOLY COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA MONOPOLY VALUATION IN PRIMARY MARKETS AGGREGATE (MARKET) SUPPLY – – – – One single supplier, it is a price seger. No price discrimina\on. The good is excludable and rival in consump\on. Complete Markets. There is NO SUPPLY FUNCTION in terms of P. SMC(Q) = PMC(Q). 2 TYPES OF MONOPOLIES: – Natural Monopolies – Ar\ficial Monopolies COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA MONOPOLY VALUATION IN PRIMARY MARKETS DEMAND AND MARGINAL REVENUE Elas\c part of the demand WTP(Q0) P1 MR(Q0) Price Elas\city equals 1. PD(Q) = SMB(Q) Q0 Q1 MR(Q) COST ­BENEFIT ANALYSIS FALL 2011 This is a result of NO PRICE DISCRIMINATION UNIVERSITY OF MINNESOTA MONOPOLY VALUATION IN PRIMARY MARKETS DIFFERENCE BETWEEN PRICE SETTER AND PRICE TAKER PRICE SETTER WTP(Q0) WTP(Q0) = P* = PD PRICE TAKER MR MR(Q0) PD(Q) = SMB(Q) Q Q0 MR(Q) COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA MONOPOLY VALUATION IN PRIMARY MARKETS ARTIFICIAL MONOPOLY EQUILIBRIUM PMC(Q) = SMC(Q) AC(Q) PM AC(QM) PD(Q) = SMB(Q) QM MR(Q) COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA MONOPOLY VALUATION IN PRIMARY MARKETS NATURAL MONOPOLY EQUILIBRIUM EVALUATE THE FOLLOWING POLICIES: 1)  The firm is forced to price AC 2)  The firm is forced to price MC QUESTION – Can the government apply this projects? – Should the gov’t run this firm or let it be private? PM AC(Q) MC(Q) PD(Q) = SMB(Q) QM MR(Q) COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EXTERNALITIES VALUATION IN PRIMARY MARKETS TYPE 3 OF OUTPUT MARKETS EXTERNALITIES COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EXTERNALITIES VALUATION IN PRIMARY MARKETS DEFINITION OF EXTERNALITY An externality exists when – the well ­being of a consumer, – or the technology of a firm – (or both) is directly affected by the ac\ons of another agent.   effects that are not mediated by prices. COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EXTERNALITIES VALUATION IN PRIMARY MARKETS MODELING EXTERNALITIES – Suppliers and demanders are price takers. – No price discrimina\on across consumers. – No arbitrage condi\on for suppliers. MAIN OBJECTIVE: – SMC ≠ PMC – SMB ≠ PMB HOW IT CAN BE ACHIEVED – The good is not rival in consump\on. – The good is not excludable. – Incomplete informa\on (private informa\on). COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EXTERNALITIES VALUATION IN PRIMARY MARKETS POSITIVE EXTERNALITY IN CONSUMPTION PMC(Q) = SMC(Q) PRICE OF EXTERNALITY WTP(Q) = SMB(Q) PD(Q) = PMB(Q) QM QEFF COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EXTERNALITIES VALUATION IN PRIMARY MARKETS NEGATIVE EXTERNALITY IN PRODUCTION SMC(Q) PMC(Q) = PS(Q) PRICE OF EXTERNALITY WTP(Q) = PD(Q) QEFF QM COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA EXTERNALITIES VALUATION IN PRIMARY MARKETS EXTERNALITY IN CONSUMPTION DUE TO LACK OF INFO PMC(Q) = SMC(Q) PRICE OF INFORMATION PD(Q) WTP(Q) = SMB(Q) QM QEFF COST ­BENEFIT ANALYSIS FALL 2011 UNIVERSITY OF MINNESOTA ...
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