Econ 423 Exam #1, Spring 2004 – Prof Hackett Your Name: _________KEY_____________

PART I -- 1. (12 pts) Suppose that in addition to the status quo (current management system), four policy options are being considered in the context of a natural resource management decision. Five members of society are affected by the management decision. The table below shows how these five people feel about the proposed management options relative to the status quo. The numbers represent the amount (in units of utility) by which the different options make them better off or worse off relative to the status quo.

Policy Options	Affected Members of Society					Net Social Utility
	Arnold	Jaime	Sharita	Brigit	Hideo
Option A	60	-20	30	40	120	230
Option B	30	0	20	-20	170	200
Option C	0	15	15	30	30	90
Option D	-30	30	0	-30	200	170

1.a. Compute the net social utility for each option and report it in the table above.

1.b. Which of the above options, if any, is Pareto efficient relative to the status quo? ____C____

1.c. Which of the above options, if any, is Kaldor-Hicks efficient relative to the status quo? ____A_____

1.d. Which of the above options, if any, is utilitarian-ethical relative to the status quo? ____A_____

Next 3 questions (Majors only): Assume an otherwise well-functioning competitive market with the following:

Demand: P = 1050 – 0.1Q; Private-cost supply: P = 50 + 0.2Q. Production of each unit of output Q above leads to a marginal external cost of $150, which implies social-cost supply: P = 200 + 0.2Q.

2. (8 points) Assuming firms can freely pollute in the absence of regulation, compute the "free market" equilibrium P, Q, and total gross gains from trade (CS + PS) using the private-cost supply equation. Show your work.

1050 - 0.1Q = 50 + 0.2Q ==> Q = 3,333.33; P = 50 + 0.2(3,333.33) = $716.67

Total gross gains from trade = [(1050 - 50)*3,333.33]/2 = $1,666,666.67

Equilibrium P = $716.67, Q = 3,333.33 units, and total gross gains from trade = $1,666,666.67

3. (8 points) Compute the dollar amount of total external cost generated when firms can freely pollute in the market equilibrium above, and derive the actual total net gains from trade. Show your work.

Total external cost = constant MEC*Q = $150*3,333.33 = $500,000.

Net gains from trade = gross gains from trade - total external cost = $(1,666,666.67 - $500,000) = $1,166,666.67

Total external cost = $500,000 and total net gains from trade = $1,166,666.67

4. (8 points) Assuming firms pay a Pigouvian tax and thus operate along the social cost supply curve, compute the "socially optimal" equilibrium P, Q, and total actual gains from trade. Assume the Pigouvian tax revenue fully offsets any remaining negative externalities. Show your work.

1050 - 0.1Q = 200 + 0.2Q ==> Q = 2,833.33; P = 200 + 0.2(2,833.33) = $766.67

Total gains from trade = [(1050 - 200)*2,833.33]/2 = $1,204,166.67

Equilibrium P = $766.67, Q = 2,833.33 units, and total gains from trade = $1,204,166.67

Next 2 questions (Nonmajors only)

2. (12 pts) Carefully draw and fully label a supply-demand diagram with negative externalities that illustrates (i) the free-market equilibrium when firms only pay marginal private costs, and (ii) the socially optimal equilibrium based on a Pigouvian tax. (iii) Show the difference in equilibrium prices and equilibrium quantities, and (iv) show the inefficiency caused by negative externalities.

Note: You can see how to answer this by looking at Figures 4.3 and 4.4 in the Hackett (2001) textbook.

3. (12 pts) Carefully draw and fully label a supply-demand diagram with positive externalities that illustrates (i) the free-market equilibrium when demand only reflects private benefits to the buyers, and (ii) the socially optimal equilibrium with demand based on social benefits. (iii) Show the difference in equilibrium prices and equilibrium quantities. (iv) In one sentence, describe an example of a market with positive externalities, and in one sentence describe an efficiency-enhancing government intervention applicable to your example.

Note: You can see how to answer this by looking at Figures 4.1 in the Hackett (2001) textbook.

(iv). The market for pastureland near cities and towns features habitat and view and floodwater storage positive externalities. An efficiency-enhancing intervention would be tax funds provided for purchase of conservation easements on pastureland, which allow for continued agricultural production and preservation of the positive externalities.

4 or 5. (12 points) Carefully draw and fully label a diagram that shows four price trend lines over time for a fixed stock of nonrenewable natural resource with positive discount rates and constant marginal cost: (i) When demand remains the same each period. (ii) When demand is growing larger each period. (iii) When demand remains the same each period but total stocks do not decline because of continuous new discoveries. (iv) When demand remains the same each period, but an alternative technology is eventually price-competitive.

Draw a diagram with price on vertical axis, time on the horizontal axis. (i) Will be an upward-sloping line. (ii) Will be will be an upward-sloping line that is steeper than in "i" above. (iii) Will be a flat or even a downward-sloping line. (iv) Will look like the line in "i" but will eventually flatten out when it reaches the price at which the alternative technology is competitive.

5 or 6. (7 points) (i ) Draw a fully labeled supply/demand diagram that shows a situation in which there is less resource available than is needed to provide for a competitive equilibrium. (ii) Show marginal Hotelling rent and total Hotelling rent in your diagram.

See figure 5.3 in the Hackett (2001) textbook and related narrative.

PART II: Matching (3 points each). Clearly write the letter for the word or phrase (on the left) beside the description (on the right) that matches it. Each word or phrase has at most one uniquely correct match.

Word or Phrase	Description
A. Opportunity cost	1. __O_ Measure of market inefficiency that represents lost gains from trade.
B. State (government) property	2. __P_ Bases the ethics of an action on the likely outcomes of the action.
C. Pareto efficient	3. __E_ Occurs in a common-pool resource under open access conditions (or other failed property rights systems) due to self-interested appropriators.
D. Kaldor-Hicks efficient	4. __K_ The property rights regime in which the rights of access, withdrawal, management, and exclusion are held in common by a group of proprietors.
E. Tragedy of the commons	5. __R_ The gap between price and marginal cost that occurs in competitive commodity markets due to resource scarcity.
F. Positive externality	6. __N_ Occurs when price is above equilibrium in a well-functioning competitive market.
G. Buy too much	7. __F_ An external benefit generated from production and exchange and enjoyed without payment by members of society.
H. Pigouvian tax	8. __Q_ Bases the ethics of an action on the intrinsic rightness of the action.
I. Total allowable catch	9. __G_ Consumers do this in markets suffering from unresolved negative externalities because price only reflects marginal private cost.
J. Usufructuary rights	10. __H_ Name of a policy intervention that internalizes negative externalities.
K. Common property	11. __C_ This efficiency criterion can only be satisfied when a policy option makes some better off and nobody worse off relative to the status quo.
L. Appropriation externality	12. __A_ When a choice is made in the context of scarcity, this is the value of the best option that had to be given up.
M. Open access	13. __J_ Certain use and withdrawal rights to property that is owned by others.
N. Excess supply	14. __M_ The property rights regime for unowned resources that anybody can access, use, or harvest.
O. Deadweight (social) loss	15. __S_ These often have secondary markets where previously used resource competes with "virgin" resource sold in primary markets.
P. Consequentialism
Q. Categorical imperative
R. Marginal Hotelling rent
S. Recyclable natural resources