Economics 423 -- Environmental and Natural Resources Economics

Mid-Term Examination 1, Fall 2002, Professor Steven Hackett

Part I: Each question is worth three points ANSWER KEY

Price	Quantity Supplied	Quantity Demanded
10	100	1900
20	200	1700
30	300	1500
40	400	1300
50	500	1100
60	600	900
70	700	700
80	800	500
90	900	300
100	1000	100

1. What is the equilibrium price __70___ and quantity ___700___ in the table above?

2. At what price in the table above is there a surplus of 600? ___90___

3. Which of the following, if any, would cause equilibrium quantity to increase? (circle any/all correct answers)

Increase in demand Increase in supply

Internalizing a positive externality Decrease in supply

4. Which of the following, if any, would cause equilibrium price to rise? (circle any/all correct answers)

Increase in demand Internalizing a negative externality

Decrease in demand Decrease in supply

5. True/False (circle one): Tyranny of the majority can happen when a diverse society sets social policy under a utilitarian system of ethics, but cannot happen if this society sets social policy under a deontological system of ethics.

False because in a diverse society, the majority can tyrannize the minority under a deontological ethical system (e.g., Taliban, Puritanism, etc).

6. True/False (circle one): Under teleological ethics, one has a categorical imperative or duty to act in a certain way.

False. The statement is true for deontological ethics, not teleological.

7. True/False (circle one): If a Pigouvian tax is larger than what it costs a firm to clean up its pollution emissions, then the firm will generally choose to clean up its emissions rather than pay the Pigouvian tax.

True because a firm can reduce its costs by cleaning up and avoiding the tax.

8. True/False (circle one): There is relatively little evidence to support the hypothesis that environmental regulations have had a large adverse effect on the competitiveness of U.S. manufacturing.

True. This is a direct quote from Jaffe et al. (1995) in Chapter 1 of the textbook.

9. True/False (circle one): Scarcity is an artificial construct created by corporations and the media, and did not exist in pre-industrial societies.

False because available food and shelter resources, as well as the amount of time and energy available to people, have always been scarce.

10. True/False (circle one): As the term is used in this class, economic rationality requires that people must conform to the preferences and materialistic tendencies of the dominant consumer culture.

False. Re-read definition and discussion in Chapter 1 for details.

11. True/False (circle one): A market failure occurs when one or more of the conditions required for a well-functioning competitive market is not met in a substantial way.

True. This is a direct quote from the textbook glossary.

Part II. Matching: There is one unique match for each of the 10 statements (3 points each)

Word or Phrase	Statement
A. Price too low, quantity too large	__M_1. This restricts the ability of the US government to take private property rights
B. Price too high, quantity too low	__I_2. If you have this you are an authorized entrant, but you are not an authorized user
C. Negative pecuniary externality	__C_3. This externality occurs when a restaurant's profitability declines due to several new restaurants opening nearby
D. Positive externality	__H_4. If you have this you are an authorized user
E. Kaldor-Hicks efficient	__A_5. This describes the distortion of the market equilibrium due to negative externalities
F. Pareto efficient	__L_6. This is the term for those who hold access, withdrawal, and management rights
G. Efficient resource allocation in a market	__J_7. This ownership regime is res nullis (no property)
H. Fishing license	__O_8. This is a government intervention in a market that internalizes negative externalities
I. Season visitor pass to CA State Parks	__K_9. One must have this in order to bring a lawsuit under common law
J. Open access	__E_10. This judges social policy to be efficient when net social benefits are maximized relative to all other options, even if some people are made worse off
K. Legal standing
L. Claimant
M. Takings clause of the 5th Amendment
N. Government failure
O. Pigouvian tax

Part III. Computational Analysis

Suppose that demand is given by the equation P = 10,000 - 10Q

Private-cost supply is given by the equation P = 1000 + 10Q

Social-cost supply is given by the equation P = 3000 + 10Q

Marginal external cost is $2000

1. (6 pts): Derive the numerical value for equilibrium price and quantity assuming that firms can freely pollute without regulation or reputational consequences. Please show your work.

P = $_5,500_ Q = __450__

10,000 – 10Q = 1,000 + 10Q è 20Q = 9,000 è Q = 450; P = 1,000 + 10*450 = $5,500

2. (5 pts): Derive the numerical value for the gross gains from trade to the market participants (ignoring negative externalities) associated with the correct answer to question 1 above. Please show your work.

Gross gains from trade = $__2,025,000__

CS = 0.5*[10,000-5,500]*450 = $1,012,500; PS = 0.5*[5,500-1,000]*450 = 1,012,500

TOTAL GAINS FROM TRADE = CS + PS = $2,025,000

3. (5 pts): Derive the numerical value for total external cost associated with the correct answer to question 1 above. Please show your work.

Total external cost = $___900,000__

SINCE MEC IS CONSTANT, TEC = MEC*Q = $2,000*450 = $900,000

4. (6 pts): Derive the numerical value for the true net gains from trade to market participants and society associated with the correct answer to questions 1-3 above. Please show your work.

True net gains from trade = $__1,125,000__

TRUE NET GAINS = GROSS GAINS – TOTAL EXTERNAL COST = $2,025,000 - $900,000 = $1,125,000

5. (5 pts): Derive the numerical value for equilibrium price and quantity assuming that a Pigouvian tax has fully internalized negative externalities. Please show your work.

P = $__6,500__ Q = ___350___

10,000 – 10Q = 3,000 + 10Q è 20Q = 7,000 è Q = 350; P = 3,000 + 10*350 = $6,500

6. (5 pts): Derive the numerical value for the true net gains from trade associated with the correct answer to question 5 above (assume that the proceeds of the Pigouvian tax goes to cleaning up the pollution or compensating those harmed by pollution). Please show your work.

True net gains from trade = $__1,225,000___

TRUE NET GAINS = 0.5*[10,000 – 3,000]*350 = $1,225,000

7. (5 pts): By how much, in dollar terms, does the Pigouvian tax above enhance market efficiency (as measured by increased gains from trade) relative to the unregulated case? Please show your work.

Increased gains from trade due to Pigouvian tax = $__100,000___

ANSWER TO QUESTION 6 – ANSWER TO QUESTION 4 = $100,000