won | WO BUILDING BLOCKS To understand how natural resources are used and to formulate policies that might influence these rates of use in desirable directions, two strands of knowledge must be brought together: knowledge of how the natural ecosys- tem itself functions and knowledge about human behavior. The first comes from scientists such as biologists, ecologists, meteorologists, earth scientists, and the like. The second comes from social scientists such as economists, polit- ical scientists, and sociologists" In this book the emphasis is on economics, the science that deals with values, incentives, and institutions governing the allo- ‘tion of productive resources! and the production of goods and services. This section is devoted, therefore, to the study of a number of primary concepts and relationships in economics. Economies is a very cumulative subject. The ‘more complex theories and models used to study complicated real-world problems are always built up from the core concepts, Thus the ideas studied in this chapter, though very simple and rather abstract, are going to be vital to the various natural resource models we develop later to look at specific re- source issues. 1 “Resources” has two meanings in economies: On the one hand it i short for “natural re- sources," on the other i soften used to zefer #0 all inputs, both natural and othervise, that are used to produce goods and services. The context s usually sufficent to distinguish the one being ted, 3940 SeCTIONTWo: BUILDING BLOCKS Virtually any human action affecting natural resources use rates has two consequences: on the one side it will normally create goods or services that have value; on the other side it will entail costs. This is true whether the action is of a private or public firm extracting or otherwise using a natural resource, or whether it is some organization, such as a government agency, that is pur- suing an explicit conservation objective. The discussion will be organized around these two sides; first we discuss willingness to pay and demand on the output side, and then we get into opportunity cost and supply on the input side.CHAPTER, WILLINGNESS TO PAY/DEMAND The first requirement is to develop some notion of value. “Value” is a word with many interpretations, but in economics it means the worth that a person or group of persons places on something, such as a particular good or service ot state of the world. The basic assumption is that individuals are possessed of a set of underlying tastes and preferences that letermine these relative values. WILLINGNESS TO PAY To make visible this notion of value in a way that it can be observed and measured, we use the idea of willingness to sacrifice. The value that a person puts on something is the amount they are willing to sacrifice to obtain that something, which may be a good, or service, or state. Sacrifice what? It could be anything. For a hermit the best index might be the time needed to produce some item. In a monetized economy it makes most sense to measure it as will- ingness to sacrifice generalized purchasing power. Thus we use willingness to pay as our fundamental concept: The value a person places on a good or service is what they are willing to pay to get that good or service. What determines how much a person is willing to pay to obtain something? Clearly individual tastes and preferences are paramount. Some people are willing to pay a lot to visit the Grand Canyon; others are not. Some people are willing to pay a lot for white-water recreation opportunities; others are not. 442. SECTION TWO, BUILDING BLOCKS Some people place a high value on trying to preserve the habitat of unique an imal and plant species; others do not. Its obvious also that a person's wealth affects the willingness to sacrifice; the greater their wealth, the better a person Can afford to pay for various goods and services. Willingness to pay, in other ‘words, also reflects ability to pay. Willingness to pay also depends upon the state of one’s knowledge and experience. For a person who has never left the city, for example, a backpacking experience may open up new opportunities and essentially shift a person’s preferences What a person is willing to pay, and what they end up actually having to pay in concrete situations, are two different things. Willingness to pay is @ rep~ Pesentation of underlying tasks and preferences. A person may be willing to pay a maximum of $6.50 to visit a particular beach for a day. What they actu- ally have to pay will depend on circumstances. Maybe itis a town beach with no admission fee or perhaps a privately operated beach with a $5 entrance fee. Willingness to Pay tilustrated Consider an individual and some arbitrary good or service. We need a way of representing graphically that person’s willingness to pay forthe item in ques- tion. We will use simple numbers for illustrative purposes. “Assume that the person has none of the good to begin with. We ask her, or perhaps deduce from watching her spend her money, how much she would Pevwilling to pay’ for a single unit of a good rather than go without. Suppose this is some number, such as $38 pictured in the top of Figure 3-1, We then Sak, assuming she alveady has one unit ofthis good, how much she would be Silling to pay'for a second unit. According to Figure 3-1, her answer is $26. In Similar fashion, her willingness to pay for each additional unit is depicted by the height of the rectangle above that unit $17 for unit 3, $12 for unit 4, and so on. These numbers depict a fundamental relationship of economics: the notion Sfdiminishing willingness to pay. As the number of units consumed in- Greases, the willingness to pay for additional units of that good goes down, ‘Quantity data (eg, consumption, production) often have a time dime such as pounds consumed per month of year, or tons produced per year. To temind ourselves of this, we could index our variables with a time indication, Such as 0/1 In the interests of notational simplicity we will sometimes leave aut the-cxplict time designator, but you should remember that itis in the background Ttis not very convenient to work with diagrams that are step-shaped as in the top of Figuee 3-1. Assume that people can consume fractions of items in audition to integer values (eg., pounds of potaioes consumed per week) What this docs is produce a smoothly shaped willingness-to-pay curve, such as the one pictured in the bottom of Figure 3-1. In effect the steps in the willingness-to-pay curve have become too smal 10 see, yielding a smooth Crve fo work with. On this smooth function we have singled out one quan- tity for illustrative purposes. It shows that the willingness to pay for the third unit is $17.CHAPTE 3; WILLINGNESS TO PAYIDEMAND 43 ot 2@ 3 4 5 6 ° 7 2 9 4 5 6 Units ofthe good FIGURE 31 The Concopt of Wilingnéss 10 Pay ‘The concept in use here is more exactly called marginal willingness to pay Suppose a person is already constiming two units of this good; according to Figure 3-1, that person would be willing to pay $17 for a third unit. This isthe marginal willingness to pay—in this case, for the third wnt. "Marginal" thus describes the additional willingness to pay for one more unit. So the height of the rectangles in the top of Figure 3-1 and the height of the curve in the bottom graph show the marginal willingness to pay for this good.44° SECTION TWO: BUILDING BLOCKS ‘The total willingness to pay for a given consumption level refers to the total amount a person would be willing to pay to attain that consumption level rather than go without the good entirely. Suppose the person is consum- ing at a level of three units; her total willingness to pay for consuming this quantity is $81, which is in fact the sum of the heights of the demand rectan- gles between the origin and the consumption level in question (838 for the first plus $26 for the second plus $17 for the third). This corresponds, in the smooth version of the willingness-to-pay function, to the whole area under the mar- ginal willingness-to-pay curve from the origin up to the quantity in question. For three units of consumption, the total willingness to pay is equal to an amount represented by the combined areas @ and b. ‘Marginal Willingness to Pay and Demand ‘There is another way of looking at these marginal willingness-to-pay relation- ships. They are more familiarly known as demand curves. An individual de- mand curve shows the quantity of a good or service that the individual in question would demand (ie, purchase and consume) at any particular price For example, suppose a person whose marginal willingness-to-pay /dlemand | curve is shown in the bottom part of Figure 3-1 is able to purchase this item at a unit price of $17. The quantity he would demand at this price is three units. ‘The reason is that his marginal willingness to pay for each of the first three units exceeds the purchase price. He would not push his consumption higher than this because his marginal willingness to pay for additional quantities ‘would be lower than the purchase price. ‘An individual's demand/marginal willingness-to-pay curve for a good or service is a way of summarizing his personal consumption attitudles and capa- bilities for that good. Thus, we would normally expect these relationships to differ somewhat among individuals because individual tastes and preferences vaty. Figure 3-2 displays several different demand curves. Panel (a) shows FIGURE 3:2 ‘Typical Demand Marginal Wilingness-o-Pay Curves @ o Quantiy(CHAPTER 3: WILUNGNESS TOPAYDEMAND 45, two demand curves, one steeper than the other. The steeper one shows a situa- tion in which marginal willingness to pay drops off fairly rapidly as the quan- tity consumed increases; the other marginal willingness to pay, although lower to begin with, goes down less rapidly as quantity increases. These two demand curves could represent the case of one consumer and two different ‘goods or services, or the case of two different consumers and the same good or service, Panel (b) of Figure 3-2 also has two demand curves; they have the same general shape, but one is situated well to the right of the other. The demand curve lying above and to the right shows a good for which the marginal will- ingness to pay is substantially higher than it is for the same quantity of the other good. What could account for the difference? They might represent the demand curves of two different people for the same good. But there are other possibilities. How much a person is willing to pay for something obviously depends on how much money she has; more than likely the higher her in- come, the more she is willing to pay. So the two demand curves in panel (b) could apply to the same individual and the same good, but at two different points in time, the one to the right being her willingness to pay after she has had a substantial increase in income. - There is another way of looking at the two demarid curves of panel (b), one that may be very important for the application of these ideas to natural re- source assets. People’s tastes depend on a variety of psychological and histor- ical factors that are hard to pin down and describe but are nevertheless real. ‘They depend in part on the experiences that people have and the information they gather over time about the qualities of different goods and how they feel about them. So, for example, the demand curve to the right could be the same consumer's demand curve for a good for which his appreciation has in- creased over time. Perhaps they are demand curves for outdoor wilderness experiences, the one to the left applying before much is known about this type of activity and the one to the right applying after the person has had wilderness experience and learned to enjoy the activity. Other factors are in- formation and psychology; the demand curve on the right might be a per- son’s demand for a good before an announcement of the presence of pesticide residues in it, with the curve on the left being the demand curve after the announcement. Note that the demand curves are in fact nonlinear, rather than straight lines. A straight-line demand relationship would imply a uniform change in the quantity demanded as its price changes. For most goods, however, this is unlikely to be true. At low prices and high rates of consumption, studies have shown that relatively small inéreases in price will lead to substantial reduc- tions in quantity demanded. At high prices and low quantity demanded, how- ever, price increases have a much smaller effect: They produce much smaller reductions in quantity demanded. This gives us a demand relationship that is convex to the origin, that is, relatively flat at low prices and steep at higher prices. Exhibit 3-1 discusses this in terms of the demand for gasoline46 SECTIONTWo: BULDING BLOCKS EXHIBIT 3-1 THE DEMAND FOR ENERGY FOR TRANSPORTATION People sometimes think of their demands This implies thatthe demand for gaso: as somewhat fixed, according to their tine might be shaped as in the dagram. AL Itestyles. Tis i offen the way people think low and moderate pices, increased prices Of their demanc for gasoline, for exampla, will lead to substantia! drops in aggregate Actually, researchers nave found these re: consumption because, paradoxically as it letonships to be somewhat more flexbla. In might seem, the higher the level of con- general, 26 the price of gasoline rises, the sumption te easiacit is to find ways of cut total consumption of gasoina declines: Al ting back. So the demand curve is elatively though individual responses wil citfr, de- flat in ths range. Bul at higher prices where pending upon peoples’ circumstances and mast of the driving Is for essential pur- preferences, the total wil deine. poses, further price increases lead 10 ‘At rolatvely low prices, gas consump: smaller crops in consumplion, and hence a tion is high: Bocause ofthe low cost of criv- steeper demand curve ing, people use thee cars with ite restraint [At somewhat highor prices, many (though ‘not necessariy a) people begin to think [about curling unessential driving, per- hhaps going to the supermarkat only once | per week rather than two oF theee limos, fnd riding with somebody else to t movies on the weekend. At still higher prices mote thought is given to reducing Unessental tving, and at very high prices people have the incentive to car-pool, Switeh to public transit, buy more fuel: fffcient vehicles, of, in the long run, move —— ‘laser to thet place of work Gasoline used Price $ Economics is sometimes misunderstood as assuming that people are driven only by thoughts of their own welfare, that they are complete egoists. Because these are individual demand curves, they do indeed summarize the attitudes of single individuals, but this does not imply that individuals make decisions with only themselves in mind. Although some people focus only on themselves, most , 5 people are influenced by other powerful motives that affect their demands for, different goods, including altruism toward friends and relatives, feelings of civic virtue toward their communities, and a sense of social responsibility toward fel- low citizens. Individual tastes and preferences spring from these factors as well- a froth more narrow considerations of personal likes and dislikes, Where an employee's Salary or Wages exceeds K385 but is less than KYUU per tortnignt Aggregate Willingness to Pay/Demand for Private Goods In examining real-world natural resource issues, the focus of attention is usu- ally on the behavior of groups of people, not single individuals. It could be all people in a single community or region, or all people in the country. It couldWILLINGNESS TOPAYOEMAND 47 Aggregate a Qventty Quantity Quantity Aggregate demanded demanded demanded uantiy byAnna by Bod by Carlos womandes FIGURE 3-3 ‘Aggregate Demanditergnal Wilingness-to-Pay Curve fr a Private Good even be all people in the world. The aggregate marginal willingness-to-pay curve is the summation of the marginal willingness-to-pay curves of all the in- dividuals in the group of interest.! The aggregate marginal willingness to pay for water by people in California, for example, is the curve that one gets from adding together the individual marginal willingness-to-pay curves for water (in terms, say, of the number of gallons used per month) of all the residents of California Figure 3-3 depicts the derivation of a simple aggregate marginal willingness- to-pay curve, in this case by adding together (horizontally) the marginal séillingness-to-pay curves of each of the three people in this group. A good like this, which can be consumed in separate and possibly different amounts by each of the individuals in a group, depending on their preferences and ‘wealth positions, is elled a private good. The total amoung consumed in this ( case is simply a sum of the individual quantities consumed\Cantaloupes are a good example, as are cars, fishing trips, and 2x 4's, At a marginal willingness to pay of $8, consumption is 10, 6, and 8 units for, respectively, Anna, Bob, and Carlos. Thus total consumption at $8.is 24. At a marginal willingness to pay of $15, aggregate consumption is 7 units (4 for Anna, none for Bob, and 3 for Carlos). Aggregate Willingness to Pay/Demand for Public Goods Many of the goocis and services produced by natural resources are not private goods, for which we add together the consumption levels of different people * to get total consumption. Rather, they are called public goods. A public good } t is one that when it is made available to one person, automatically becomes available to others as well. A good example is a signal broadcast by a radio sation. When the signal is sent out, it is available to anybody within range "Remember tha total willingness o pay isthe area under the MWTP curve ofeach individual — consumer, whereas aggregate willingness to pay isa summation overa ntimber of individuals.48 SECTION TWO. BUILDING BLOCKS TABLE 3-1 AGGREGATE MARGINAL WILLINGNESS TO PAY FOR RESTORING BALD EAGLES ‘Marginal witingness to pay (MWTP) Exton of restoration anna Bob Carlos Aggregate 0 10 2 as 20 5 10 5 Extonsive 10 ° 5 16 who has a receiver. Furthermore, this type of public good is available to every. individual in essentially the same quantity; in other words, the amount that cone person listens does not diminish the amount available to other potential listeners. Goods and services are defined as public or private in microeconomics be- cause of their technical characteristics, not because of whether they are pro- duced by public agencies or private firms. If a radio station “scrambled” its signal, and then rented unscramblers to subscribers, the signal would then be a private good. Public agencies may provide private goods (publicly provided flood insurance, for example); private firms may provide public goods (the radio station example). And the difference between public and private goods is not that the former is in some sense of greater social importance than the lat- ter. It is strictly a distinction based on the technical characteristics of the good in question. To find the aggregate marginal willingness to pay for a public good, we must proceed somewhat differently from the case of a private good. Consider a program designed to reestablish a certain species of wildlife in a region, for example the restoration of the bald eagle in New England. Let the group of people involved consist of three individuals, the same three we mentioned above. Their individual marginal willingnesses to pay are listed numerically in Table 3-1. Three alternative discrete levels of restoration are identified: “low,” “moderate,” and “extensive,” corresponding, for example, to the num ber of adult animals that would be expected to survive under each scenario. ‘The marginal willingness to pay (MWTP) for Anna, Bob, and Carlos are as shown. For example, Anna would be willing to pay $50 for a light restoration program, and $30 more if it were increased to a moderate level, and so on. Bob has a lower marginal willingness to pay than Anna, and Carlos lies between the other two in terms of MWTP. The restoration of the bald eagle is a public good, in the sense just described. If it were carried out for one person it would be available to others as well. To find the aggregate marginal willingness to pay in this case, we add together the individual MW'TPs corresponding to given “output” levels (in this case different levels of restoration). This is done in the last column of Table 3-1 Figure 3-4 shows the derivation of the aggregate marginal willingness to pay in graphical terms. In contradistinction to the private good, where the agCHAPTERS: WILUNGNESS TO PAYIDEMAND 49 Aggregate 8 0 Git Wed Bxensive FIGURE 3-4 ‘Aggregate Marginal Wilingness to Pay/Demand fora Public Good gregate MWTP is found by adding individual curves horizontally (i.e., adding quantities of the three individuals corresponding to the same MWTP), we in- stead add the individual curves together vertically (.e,, the marginal willing- zness to pay of the three individuals corresponding to the same quantities on the horizontal axes). Willingness to Pay and Benefits ‘We now come to the idea of benefits. Benefits is one of those ordinary words to which economists have given a technical meaning. The word “benefits” clearly implies being made better off. If someone is benefited by something, her position is improved—she is better off. Conversely, if benefits are taken from her, she is worse off. How do we confer benefits on somebody? We do this by giving her something she values. How do we know that she values something? We know by the fact that she is willing to sacrifice, or willing to pay, for it. Thus, the benefits that people get from something are equal to the amount they are willing to pay for it. ‘The logic behind this definition of “benefits” is quite strong. It means we can use ordinary demand curves to measure the benefits accruing to people from given quantities of a good or service. For example, Figure 3-5 shows two demand curves, and on the horizontal axis two quantity levels are indicated.50 SECTION TWO: BUILDING ALOCKS ‘Quantity FicuRE 3.9 Vilingness to Pay and Benefits # Suppose we wish to estimate the total benefits of increasing the availability of this item from quantity 4: to quantity q. Benefits are measured by willingness to pay, and we know that total willingness to pay is measured by areas under the demand curve—in this case the area under the demand curves between quantity qi and quantity q2.So for the lower demand curve the benefits of such an increase in availability are equal to an amount shown by area b, whereas benefits in the case of the higher demand curve are equal to the total area « +b. ‘The logic of this seems reasonable. The people with the higher demand curve must place a greater value on this item; whatever it is, they are willing, to pay more for it than the people whose demand curve is the lower function. This is in agreement with common sense. The more people value something, the more they benefit by having more of that something made available, or, (© say the same thing a different way, you can’t damage people by taking away from them something that they don't value. This is a fundamental notion underlying natural resource economics. It un- derlies, for example, questions such as the benefits conferred on people when natural resources are used in production, as compared to the benefits they would provide if preserved. It underlies the question of evaluating the im- pacts of environmental programs and policies undertaken by local, state, and federal governments. This is its strength—the fact that itis based on a clear notion of the value that people place on different things. But the idea also has shortcomings. For one thing, demand and, therefore, benefits are often very hard to measure when natural resource questions areCHAPTER'S: WILLINGNESS TOPAVDEMAND 51 concerned, as we will see in later chapters. For another, we have to remember that demand curves are critically affected by the ability to pay for something as well as preferences. In Figure 3-5, for example, the lower demand curve could represent a group of people with lower incomes than those with the higher demand curve. The logic of the argument would lead to the conclusion that the increase in quantity of q2 ~ g: would produce fewer benefits among Iower-income people than among higher-income people. This may not be a very equitable conclusion, depending on the circumstances. Thus, although the logic of the concept is clear, we have to be careful in using it, especially when we are dealing with groups of people with diverse income levels. To do 0, we must find out a5 clearly as possible how the various natural resource policies and programs, present or proposed, affect people at different income levels, We discuss this at greater length in later chapters. ‘One other possible problem exists in using conventional demand curves to measure benefits. An individual's demand for something is clearly affected by how much he krows about it a person would not be wiling to pay fora ood if, for example, he were ignorant of its very existence. In Figure 3-5, the higher demand curve might be the demand for a biodiversity product after itis found to contain a promising pharmaceutical product, while the lower demand curve shows demand before this fact becomes known. This is not especially surprising; people do after all become more knowledgeable about things ov time as a matter of education, experience, and the availability of information.\, But people's views about the importance of particular resources and the place » of nature in their lives are often blown back and forth almost from day to day, by the media, by the scientific press, and so on. Care must be exercised in tak- ing people’s demand curves of the moment, influenced as they are by all kinds of real and imagined factors, as true expressions of the benefits of actions af- fecting natural resources. They are highly relevant, but they need to be taken with a certain amount of caution. Willingness to Pay Over Time Problems in natural resource economics are particularly complex because the time factor plays a major role in them, Decisions made today, or this year, will hhave consequences in future years. Trade-offs are necessary because present and future willingness to pay, and present and future costs, are involved. We talked above about willingness to pay as it applied to the consumption of a certain quantity of a good or service. The assumption was that we were work- ing with events in the present. But consumers are usually involved with streams of consumption over a series of periods. If a person buys a car, for ex- ample, the services of the car will be realized both today and in the future over its service life. The consumption of necessities such as food, clothing, and shel- ter by definition occur over a series of years, not just a single one. Thus con- sumers can be thought of as having a willingness to pay not just for current consumption, but also for a stream of consumption quantities extending into the future, as pictured in Figure 3-6. This shows a sequence of willingnesses to52. SECTIONTWO: BUILDING BLOCKS Next year Years FIGURE 3-6 \Wiltingness to Pay over Time pay, for the current quality qo, and for a sequence of future quantities, 4x, 42.43. and so on. The problem immediately presents itself of adding up willingness-to-pay amounts over a string of years to find the total willingness to pay for the over- all sequence. How can (or should) values of willingness to pay (or of cost, as ‘we shall see in the next chapter) occurring in different time periods be added together. The standard answer to this is by discounting future values. DISCOUNTING Discounting involves applying a discount factor to future values in order to convert them into present values. Most people readily understand compound- ing. If a sum of money equal to $M is put in a savings account at an interest rate of r the value after one period of compounding is given by the formula SEV =SMqa +n) ‘The formula compounds the present value ($M) into the future value (FV). If Mis left in the bank account at r percent interest for t periods, then the future value is found by compounding the present value f times, thus, FV, =M( +2) As an example, if M = $1,000, r = 0.04, and the future value is FV = $1,000(1 + 0.04) = $1,265, Discounting is the reverse of compounding. It is a procedure for finding the present value corresponding to some future value. Discounting answers theCHAFTERS. WILLINGNESS TO PAY.DEMAND 53 ‘question: If I expect to receive something of value in the future, what is it worth today? Or, for example, if someone promised you a sum of money next year or a lesser sum of money this year, which is the better deal? Alge- braically, the expressions for present values are simply the ones above but re- arranged to get present value (which we will now call PV instead of M) on the left hand side. Thus, for example, the present value of a sum equal to $FV to be realized one period from now, ata discount rate of r, is SSRVE arn SPV Suppose somebody gave you an IOU stating that they will pay you $100 one year from now, and that the discount rate is 4 percent. The value of that IOU is the present value of that future $100, and is found with the expression ee mesi00 = 2100s gy (1+ 0,04) send ‘This means that $100 one year from now is the same as having $96.15 today, based upon a discount rate of 4 percent. Suppose the IOU was for $100, but to be given to you 5 years from now rather than after just one period. Then the present value of the IOU would be: “a | Cee (+ 0.08)5 ~ seas SPV What discounting does is to translate future values into a single metric, that of present value. So, for example, if we had numerous different future values ‘occurring in various future years, we can convert them all to present values and aggregate them in those terms. For example, suppose the IOU given to you specifies the following payment schedule: Payment $100—«S100" «$150 «S150 «$5050 2 We are assuming that the payments are made at the beginning of each year. Remember the 8 pay 5 ofeach ye ‘convention tht the present period is indexed O and is not discounted, nest period is indexed 1 and is discounted ane perio’ ete54 SECTION TWO! BUILDING BLOCKS. ‘The present value of this stream of payments? is found as follows: $150 Gene $50 an $50. tens 100, _$150 PV = $1004 + Gant Gene If the discount rate is 4 percent, this present value sum is equal to $545.18. * Now we are able to aggregate the willingness-to-pay amounts shown in Figure 3-6. The present value of the stream of total willingness to pay is equal to (+a, +f, em, PM = TS ane ‘The areas under the curves at each quantity for each year are the values of FV for that year. The same approach is used to find the present value sum of a se- quence of costs. Note that the discount rate is set equal to zero, all the discount factors go to unity, and we are just adding up the annual values without alter- ation. For progressively higher discount rates the present value aggregate be- comes smaller and smaller, because the denominators in the present value for- mula get progressively larger. At very high discount rates the discounted future values become very small compared to current values. SUMMARY ‘The primary way of registering value in economics is through willingness to pay. This does not mean that “money is the only thing of value,” but only that willingness to sacrifice is the underlying concept, and a monetary index is the ‘most convenient index of making it visible. We introduced marginal and total willingness to pay, for individuals and for groups of individuals (called aggre- gate measures). Willingness-to-pay curves are more familiarly known as de- mand curves. We distinguished between two fundamental types of goods: pri- vate goods and public goods. The difference lies in the technical nature of the goods and not in the institutional means chosen to supply them. The step from. individual to aggregate willingness-to-pay curves has to be carried out differ- ently for the two types of goods. People's willingness to pay for something normally extends over time, and this presents the problem of adding, up will ingness-to-pay amounts that occur in different time periods. This is done through discounting, which is essentially the reverse of the compound inter- est process. 2 A generalized way of writing thisis PV: tesCHAPTERS: WILLINGNESS TOPAYIDEMAND 55: KEY TERMS Value Private good Marginal willingness to pay Public good Total willingness to pay Benefits Aggregate willingness to pay Ability to pay Demand Discounting QUESTIONS FOR FURTHER DISCUSSION 1 We talked about willingness to pay for a good or service. How does the concept apply to an act of strict preservation, in which the flow of goods and services from a natural resource is put at zer0? There are ways of expressing value alternative to using willingness to pay. Can you think of some? 43 Calculate the present value of the following sequence of willingnesses to pay: this year, $100; next year, $150; year 2, $150; year 3, $50, Use a 5 percent discount rat. Recalculate using a discount rate of 8 percent. What is the effect of using a higher discount rate? 4 Is a movie theater a public good? How about a “public” telephone? A lighthouse? A ‘bus? The music you are playing on your stereo? 5 Suppose your house or apartment has become very cluttered and messy and needs to be cleaned. As you proceed through the tasks of cleaning, how does the marginal ‘willingness to pay for more cleaning change? Which tasks generate the greatest im- pact or benefit, and which tasks the least? USEFUL WEB SITES Several web sites put together by economists feature introductory text material + Essential Principles of Economics: A Hypermedia Approach, by Roger A. McCain of Drexel University (http://william-king,www.edu/top/prin/txt/Eco ‘Tochtml); Chapter 5 contains an introduction to demand theory + Cybereconomics: A Semi-Interactive, Almost-Multimedia Way to Learn Econom- ics, by Robert E. Schenk, of St. Joseph’s College (http://ingrimayne. saintjoe.edu/econ/ TitlePage.html); See the chapter on “The Logic of Choice.” * Essential Microeconomic Principles, by John Bouman, of Howard Community College (http: //www-howardce.edu/social_science/microbk.htm), unit 2 ‘Some of the most successful commercial web sites are based on letting people express their willingness to pay for various items: + For airline tickets, http://www priceline.com * For almost anything else: http:/ /www.ebay.com * The Chicago Board of Trade (http://www.cbot.com) hes an on-line auction featuring the demand and supply of recyclables (under programs and ser- vices of CBOT’s EcoCenter)56 SECTION TWO: BUILDING ALOCKS SELECTED READINGS ‘The subjects covered in this and in the next several chapters are treated in all introductory microeconomics textbooks. The best way to proceed, in order to get a longer treatment and deeper understanding of the ideas, is to consult the appropriate chapters of one of these books, Some of the more popular ones are the following: Baumol, William J., and Alan S. Blinder: Microeconomics, Principles and Palicy, 8th ed., Harcourt Brace Jovanovich, Dallas, TX, 1999, Chapters 5,7, 8. Boyes, William, and Michael Melvin: Economics, 4th ed., Houghton Mifflin, Boston, ‘MA, 1999, Chapter 3, Heilbroner, Robert L., James K. Galbraith, anc Thomas Beveridge: The Economic Prob- lem, Sth ed,, Prentice-Hall, Englewood Cliffs, NJ, 1990, Chapter & Lipsey, Richard G., Peter O. Steiner, and Douglas D. Purvis: Economics, 11th ed., HarperCollins, New York, 1992, Chapter 4 ‘McConnell, Campbell R,, and Stanley L. Brue: Economics, 14th ed., McGraw-Hill, New ‘York, 1998, Chapters 23 and 24 Parkin, Michael: Economics, 5th ed, Addison-Wesley, Reading, MA, 2000, Chapters 7,10. Samuelson, Paul A., and William D, Nordhaus, Economics, 1th ed,, McGraw-Hill, New York, 1998, Chapters 6,8 Schiller, Bradley R.: The Microeconomy Today, 8th ed., McGraw-Hill, New York, 1999, ‘Chapter 2 Waud, Roger Nz Microeconomics, Sth ed., HarperCollins, New York, 1992, Chapters 4 and 5.