SECTION II
Building Blocks
Chapter 3
Willingness to Pay/Demand
People’s tastes and preferences determine the
values that people place on goods or services
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1. Willingness to Pay (WTP)
• The value a person places on a good or service is
what they are willing to pay to get that good or
service
• Diminishing marginal WTP (MWTP): as the
number of units consumed increases, the MWTP
for each additional unit of that good goes down
• Total WTP for a given consumption level:
– the sum of the heights of the demand rectangles
– the whole area under the marginal WTP curve from
the origin up to the consumption quantity
Page 43: Figure 3-1
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MWTP and Demand
• MWTP curve is demand curve
• Figure 3-2, Panel (a)
– Two D curves: one consumer, two goods; two
consumers, the same good
– The steeper D curve: MWTP drops off more rapidly as
the quantity consumed increases
• Figure 3-2, Panel (b)
– Two D curves: two consumers (tastes, income…), the
same good; one consumer (tastes, income…), the
same good, at two different points in time
– The D curve lying above: MWTP is higher for the
same quantity
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Aggregate MWTP/Demand Curve
• Definition: the summing of the MWTP curves of
all the individuals in the group of interest
• For private goods: horizontal summing
– Figure 3-3, page 47: at each price, the total amount
consumed is a sum of the individual quantities
consumed
• For public goods: vertical summing
– Figure 3-4, Table 3-1, page 48: at each quantity, the
total MWTP is a sum of the MWTP of all individuals
– A public good is one that when it is made available to
one person, automatically becomes available to others
as well
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WTP and Benefits
• “Benefits”: this word implies being made
better off; flow from natural resource
utilization and preservation
• The benefits that people get from something
are equal to the amount they are willing to pay
for it
– Because she values something, so she is willing to
sacrifice, or willing to pay for it
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• Figure 3-5, page 49
– The total benefits of increasing the availability of
something from q1 to q2 = area b for the lower D
curve, or area a+b for the higher D curve
– Increase in quantity of q1 ‒ q2 would produce fewer
benefits among lower-income people than among
higher-income people
– The higher D curve might be the demand for a
biodiversity product after it is found to contain a
promising pharmaceutical component; the lower D
curve shows demand before this fact becomes
known
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WTP Over Time
• Decisions made today, or this year, will have
consequences in future years
• Consumers are usually involved with streams of
consumption over a series of periods
• Figure 3-6, page 51: a sequence of willingnesses
to pay for a sequence of quantities q0, q1, q2, q3 …
• How can values of WTP occurring in different
time periods be added together?
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2. Discounting
Compounding
• If a sum of money (M) is put in a savings account
at an interest rate of r, the value after one period
of compounding is
FV = M(1+r)
• If M is left in the bank account for t periods, then
the future value is
FV = M(1+r)t
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Discounting
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T
PV  
t 0
FVt
(1  r ) t
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Chapter 4
Costs/Supply
Courses of action that are optimal for society
clearly cannot be distinguished without taking
both benefits (D) and costs (S) into account
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1. Opportunity Cost
• The opportunity costs of inputs (equipment,
fuel, materials, crew… for commercial fishing)
are the values they would have produced in their
best alternative
• Include “out-of-pocket” cash costs but are much
wider than this
– Input service provided by the fisher’s spouse
– The environmental cost of a production process
(pollution costs)
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You are considering attending a concert.
ECO 285-Ch 1
Ticket price: $35; cost of driving and parking: $20
In order to attend the concert, you will have to take
time off from your part-time job (5 hours,
$6/hour).
Your opportunity cost of attending the concert
= explicit cost + implicit cost
= dollars actually paid out + value of something
sacrificed when no direct payment is made
= ($35 + $20) + ($6 x 5) = $85
When you spend $55 to buy a concert, you give up the
opportunity of buying something else.
When you spend 5 hours to attend a concert, you give up the
opportunity of doing something else like your part-time job.
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2. Cost Curves
∆TC
MC =
∆Q
• Marginal cost is the change in total cost resulting
from a one-unit change in the quantity of output
• Marginal cost works in both directions:
– It is the added costs, the amount by which total costs
increase when output is increased by one unit
– It is the cost savings if production were to decrease
by one unit
• Figure 4-1, page 59: step-shaped; smooth
• Total production costs:
– The total area of the rectangles; the area under the
marginal cost curve between the origin and the
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quantity in question
3. The Shape of Cost Curves
• Figure 4-2, page 60
• (a): short-run marginal cost curve
– At low levels of output, the plant is not being fully
utilized. As output increases, marginal cost declines
– Increasing marginal costs: at higher output rates, the
capacity is approached, marginal cost begins to rise
• (b): long-run marginal cost curve (our focus)
– Less curvature: marginal cost eventually increases but
less steeply since there is time to expand the size of
the plant
– At larger output, marginal costs of the larger plant
will be lower than those of the smaller plant
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4. Social Costs
• Refer to all the costs to society of a particular
course of action
• Figure 4-3, page 62:
– a marginal social cost (MSC) curve for the protection
of wildlife species diversity in a given geographical
area
– The out-of-pocket costs of the plan, the opportunity
costs of the land uses, the damage costs…
– At a 50% preservation level, the marginal cost is $p,
the total costs is an amount equal to area a
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5. Present Value of Cost
• Resource development/protection programs
normally extend over long periods of time, with
costs being incurred each year throughout their
life
• Costs in the current period (C0) = the area under
today’s marginal cost curve (MC0) up to today’s
rate of output (q0)
• Present value of a stream of costs: Figure 4-4,
page 63 (r is the rate of discount)
C1
C2
C3
Present value of costs = C0+ 1  r  (1  r )2  (1  r )3  ...
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6. Costs and Technological Change
• Technological change normally makes production
less costly
• This shifts the marginal cost curve downward (as a
result of the research and development that has
gone into the technology): Figure 4-5, page 63
• The marginal cost of generating electricity from
solar energy today is a fifth of what it was 25
years ago
• There has also been major technical change in
traditional fossil-based industries
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7. Costs and Supply
• Firms’ marginal cost functions are their supply
functions
• Aggregate supply function for an industry is the
aggregation of all the individual firm’s marginal
cost/supply curves
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Ch3 HW
Pages 54-55, Questions for Further Discussion:
1. Hint: are you willing to pay for what (use
values and nonuse values)?
3.
5.
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Ch4 HW
Page 66, Questions for Further Discussion:
1. a. and c.
a. The opportunity cost: a piece of land that is
to be devoted to a public park
The values that land could have produced had it
been used for some other purpose, as well as
the out-of-pocket costs of constructing and
maintaining the park
4.
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