Economics 309 Mid-term Examination, Spring 2005, Professor Steven C. Hackett

There are seven questions below. I will grade five of them – each is worth 20 points, with each subsection of equal weight. Please review all seven questions and select two that you do not want to answer. Draw a large X through the entire question (and the space below it) for each of the two questions you do not want me to grade. Note that if you fail to draw a large X through the entire question, I will select a question at random to delete. Think carefully before you answer, and write clearly and legibly.

I. Suppose there is a non-renewable natural resource commodity (e.g., natural gas) that is traded in a reasonably well-functioning competitive market, as we defined the term in class. Suppose that the resource has a variety of substitutes. 1. Draw two supply-demand diagrams below, one for the resource, and one for a substitute. 2. Show what happens as the supply of natural gas declines over time in both diagrams. 3. Describe in words how market price conveys information on the scarcity of the resource to consumers, and how consumers respond. 4. How is this process distorted if government pursues a “cheap energy” strategy in which current energy production is subsidized?

1. You should be able to do this. If not, review content from Chapter 3. Be sure to fully label your diagram.

2. You should show that supply is decreasing for natural gas due to it being depleted, which causes the equilibrium price to rise. Higher price for natural gas reduces quantity consumed, some due to conservation, some due to switching to the substitute.

3. In a reasonably well-functioning competitive market, a rising market price communicates to consumers that either supply is declining, demand is rising, or both. Rising prices encourage consumers to reduce consumption and seek alternatives.

4. A “cheap energy” policy distorts the information on scarcity being conveyed by market price, encouraging excessive amounts of consumption and depressing the market for alternatives. Cheap energy now will likely mean much higher prices in the future as the resource is depleted.

II. (i) What is land tenure? (ii) Do women in many societies have primary responsibility for farming and raising food, and do they have equivalent land tenure rights as men? (iii) In general, how does a lack of secure land tenure affect sustainable land management practices? (iv) How are land tenure and property rights related to the ability to provide collateralization for loans to enable people to capitalize small businesses?

i. Land tenure refers to the rights, responsibilities and restraints that individuals and groups of individuals have with respect to the use and occupancy of land. Customary land tenure oftentimes is linked to common property arrangements, and may include aspects of religious significance and of a permanent home attached to land. Formal land tenure systems are officially recognized and sanctioned, while informal land tenure systems are not officially sanctioned or recognized by the courts or government, but are practiced and accepted as an unspoken long-term customary practice.

ii. Yes.

iii. There is little incentive to invest time, energy, and money in durable land improvements (soil fertility, erosion control, planting of trees crops, agro-forestry, etc) that have a large up-front cost but generate returns over time, if your don’t know if you will have the right and ability to receive the future flow of produce from the land.

iv. Land can serve as collateral against a loan, and secure rights to the product of the land provides evidence of a flow of income that can be used to repay loans.

III. (i) What is the Law of Comparative Advantage and how does it explain the reason for and pattern of international trade? (ii) Create a simple two-country, two-good numerical trade example where the two countries differ in terms of their ability to produce the two goods, and use that numerical example to identify comparative advantage and the material gains from trade (relative to no trade and the people of the country dividing their time allocated to producing the two goods in half.

i. Law of Comparative Advantage states that countries (or other distinguishable trading parties) should specialize in those productive activities where their opportunity cost is lower than that of their potential trading partners.

ii. You can view the slide show for relevant course content to see a numerical example.

IV. (i) What is the WTO position on regulations affecting how internationally traded products are made (e.g., labor and environmental production standards), and how does that relate to the sustainability of the world trade system and the “race to the bottom?” Address non-product related PPR’s in your answer. (ii) What are ecolabels, and how does the WTO position on PPR’s relate to or impact ecolabels?

i. WTO position is that governments generally do not have the right to erect trade barriers based on how products are made. An exception is Article XX. Firms operating in highly regulated rich countries may be tempted to move to a country that offers the firms a place to produce that has few health, safety, or environmental regulations. The firm can then export their product back into the economy of the rich country. Firms that remain in the rich country are thus at a competitive disadvantage, and demands will be made to reduce regulatory standards in the rich countries in order to protect jobs and industry. This is the race to the bottom.

ii. Ecolabels are programs, ideally run by a government agency or a respected third party organization, that place labels on products based on either the content of the product (i.e., no pesticide residue, no animal fat, no GMO’s, etc) or on how the product is made (i.e., sustainable harvest methods, shade-grown, fair trade, etc). The WTO position is that content ecolabels are ok, but ecolables based on process or production methods (PPM’s) are inconsistent with WTO rules that respect the sovereignty of the producing nation’s regulatory system.

V. (i) Draw the birth rate/death rate chart associated with the demographic transition model and explain each stage. (ii) Briefly explain the economic arguments for falling birth rates (and define total fertility rate), as well as the cultural arguments, and the “empowerment of women” arguments. (iii) What did Nobel Prize winning economist Amartya Sen say about whether per-capita income or education and empowerment of women better explains the declining and low birth rates of stages 3 and 4 of the demographic transition? (iv) What does the evidence support?

i. See textbook, slides, or website material for an example of the demographic transition diagram. Key is that “y” axis is birth or death rates, “x” axis is for stages of development, death rates start high and fall in stage II, birth rates start high and fall in stage III, both stabilize at lower levels by stage IV. Note that the total fertility rate is the average number of children born to a woman over her reproductive lifetime.

ii. Economic: In industrialized countries, children no longer needed for agricultural work; children are more costly to educate in an industrialized country; one doesn’t need children for old-age income security in industrialized countries; women have a higher opportunity cost of their time in industrialized countries (access to the workforce). Cultural: Changes in norms regarding ideal family size; move away from traditional culture and religion toward secular culture. Empowerment of women: Women have access to workforce, raising their opportunity cost of being a child-rearer; women have more power over reproductive choices, and better access to family planning and contraception.

iii. Sen argued that education and empowerment of women was a more important cause of declines in total fertility rates than per-capita incomes.

iv. Evidence from India, Brazil, etc tend to support Sen; less evidence for per-capita income.

VI. (i) Carefully describe the debt crisis of the early 1980’s – how did it happen, and how did it threaten the world’s financial system? (ii) What was the role of the International Monetary Fund (IMF) in restructuring this debt? What system did they put in to place? (ii) What was the purpose of structural adjustment programs, what changes did they impose, and why? (iii) How effective were these programs in reducing the overall debt burden of indebted low-income countries? (iv) How did structural adjustment affect the supply and demand (and price) of commodities supplied by lower-income countries, including the barter terms of trade, and how did these changes affect the quantity of commodity production necessary to continue servicing external debt? (v) In what specific ways did structural adjustment undermine the sustainability of the societies upon which they were imposed (economic, social, and environmental)?

i. Large development projects were debt-financed in 1960’s – 1970’s. Inappropriate scales, ill-designed for unindustrialized societies; kleptocracies found various ways to steal development loan $$. Variable interest rates by late 1970’s were nearly 20 percent. Commodity and oil prices were falling by early 1980’s. All these factors undermined ability of many indebted countries to service their debt. Concerns about default on loans and the effect on the world banking system led to the Baker plan. See below.

iia. IMF’s role in this process was to restructure these lower-income countries’ debt to help prevent debt crisis.

iib. SAP’s were designed to restructure low-income countries’ debt to assure repayment and prevent debt crisis. Imposed austerity programs on domestic health and education spending, devalued currencies, privatized formerly government-owned industries (i.e., transforming effectively socialist economies into more capitalist economies), and refocused production on commodities that could be exported to rich countries for hard currency to be used for repayment of loans.

iii. Lots of interest payments made to the lenders, but less progress on principle amount. By the end of the 1980’s, overall indebtedness had not declined.

iv. Focus on “cash crop” commodity exports caused world commodity supply to increase faster than demand, resulting in falling commodity prices. Meanwhile finished goods’ prices did not decline, which caused the barter terms of trade to decline for commodity exporters. Thus more commodity harvest and production was necessary to maintain export revenue stream to support debt service payments.

v. Environmental: Unsustainably high resource harvest linked to demands to service external debt, undermining natural capital; Economic: Stubbornly high external debt levels, lack of investment in human and constructed capital; Social: Undermining health and education of the citizens.

VII. (i) What is GDP? What does it measure? (ii) Describe as many of the shortcomings of GDP as a measure of sustainability and well-being as you can. (iii) If you wanted to construct an indicator of weak-form sustainability, what would you want to be measuring – explain. (iv) Describe Green GDP, and in what way is it a better indicator of weak-form sustainability than GDP? (v) Describe Genuine Savings, and in what way is it a better indicator of weak-form sustainability than GDP? (vi) Describe the Genuine Progress Indicator, and in what way is it a better indicator of weak-form sustainability than GDP? (vii) Describe the shortcomings of these indicators.

i. The market value of all final goods and services produced in a country in a given year. The sum of spending by consumers, government, business, and foreign buyers (net of our consumption of imports).

ii. GDP leaves out valuable things that are not traded in markets (parenting, volunteerism), it counts spending on social and environmental problems as a gain without counting the original problems as a cost; it ignores how income is distributed; it treats revenues from resource depletion the same as revenues from sustainable harvest….

iii. You would want to measure the levels of the various capital stocks, and determine the extent to which the overall flow of beneficial goods and services from these capitals is unimpaired over time.

iv. An adjustment to gross domestic product (see the “gross domestic product” entry below) that takes into account declines in nonrenewable resources, expenditures on pollution control, and external costs due to pollution. A method of integrating environmental impact into GDP.

v. Genuine savings = I – r(R – g) – (e – d). It takes into account investment in constructed and human capital (I) as well as disinvestment in the environment and natural resources, and thus is a better indicator of sustainability than GDP. In the present context where there are positive levels of pollution deposition [(e – d) > 0] and resource stocks are being depleted [r (R – g) > 0], genuine savings are less than investment I in human and human-made capital. The implication is that we must make further investments in order to maintain a constant sum of human, human-made, and natural capital.

vi. The Genuine Progress Indicator starts out with personal consumption expenditures and then adds and subtracts various factors discussed in the answer to ii. above. By including social and natural capital it offers a better overall indicator of sustainability than GDP.

vii. Big problems include measurement of social and environmental adjustment factors. Disagreement on how to measure them can undermine agreement on the need to find a more holistic measure of well-being than GDP. One might also note that these weak-form indicators do not address carrying capacity and other issues linked specifically to natural capital and strong-form sustainability.