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Chapter 3

Willingness to Pay/Demand

People’s tastes and preferences determine the values that people place on goods or services

SECTION II Building Blocks

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

2Page 43: Figure 3-1

• 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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MWTP and Demand

• 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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Aggregate MWTP/Demand Curve

• “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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WTP and Benefits

• 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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• 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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WTP Over Time

2. Discounting

• 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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Compounding

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Discounting

10t

tT

t r

FVPV

)1(0

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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

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.

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. 13

ECO 285-Ch 1

2. Cost Curves• 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 quantity in question

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∆TC∆Q

MC =

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 15

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)

Present value of costs = C0+

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...)1()1(1 3

32

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r

C

r

C

r

C

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 HWPages 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 HWPage 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 parkThe 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 park4.

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