Economics 423 Exam 1, Professor Steven Hackett, Fall 2007

Name (1 point): Answer Key (answers in italics) Pick any 2 questions you do NOT want to answer and cross them out with a BIG X. Each of the remaining 33 questions below is worth 3 points.

Do either Part 1 or Part 2 below:

Part 1: Only for students not participating in the 4^th unit lab

1. Clearly draw a parallel social-cost supply curve that intersects the price axis at a value of $20 in the diagram above. Show how negative externalities result in too much electricity consumed (Q) at too low of price (P), relative to the socially optimal. Use arrows in your diagram.

See dotted lines in diagram above

2. Marginal external cost is a constant $10 per megawatt-hour in question 1 above. If 40,000 megawatt-hours of electricity are consumed per day in the “free market” equilibrium, then:

Total daily external cost in the “free market” equilibrium = $400,000 = $10 x 40,000

3. Suppose that 25,000 megawatt-hours of electricity are consumed in the “socially optimal” equilibrium in question 1 above. In the space below, very briefly explain the types of actions or choices that consumers can make over time that would allow them to reduce their consumption of coal-fired electricity by 15,000 megawatt-hours per day.

· Conserve energy

· Buy more energy-efficient appliances and devices

· If possible, produce or buy renewable energy

4. Now suppose that marginal external cost is a constant $30 per megawatt-hour, instead of $10. Using the diagram above, if a $30 Pigouvian tax were to be implemented, what would be the quantity of coal-fired electricity produced in this market under socially optimal conditions?

Q_so = 0 megawatt-hours per day. To see this, not e that the social-cost supply curve will now intersect the “y” axis at $40.

Part 2: Only for students participating in the 4^th unit lab

Suppose that daily electricity demand is given by the equation P = 100 – 0.002Q

Private-cost electricity supply is given by the equation P = 20 + 0.002Q

Social-cost electricity supply is given by the equation P = 60 + 0.002Q

Q is in megawatt-hours. Marginal external cost is $40 per megawatt-hour.

1. Derive the numerical value for equilibrium price, quantity, and true net gains from trade in the “free market” equilibrium, assuming that firms can freely pollute without regulation or reputational consequences. Please show your work.

P = $ 60 Q = 20,000 True net gains from trade = $ 0

2. Derive the numerical value for equilibrium price, quantity, and true net gains from trade in the “socially optimal” equilibrium, assuming that a Pigouvian tax has fully internalized negative externalities, with tax funds used to offset damage costs. Please show your work.

P = $ 80 Q = 10,000 True net gains from trade = $ 200,000

3. Tax incidence refers to how the burden of a tax is shared among consumers and producers. Consumers share the burden of the tax by way of higher prices. What percentage of the Pigouvian tax in question 2 above is the consumers’ burden, and what percentage is the producers’ burden? Please show your work.

Consumer burden = 50 % Producer burden = 50 %

4. Suppose that a renewable source of electricity could supply the market at a price of $70 per megawatt-hour. This source would not be subject to the Pigouvian tax. If the polluting source of electricity is subject to a Pigouvian tax as in question 2 above, then electricity from which type of source will prevail in the market?

Renewable energy Polluting energy Cannot be determined (circle one)

Part 3: All students

5. Which of the following, if any, in the table below would usually cause equilibrium quantity and equilibrium price to increase in a competitive market? (circle any/all correct answers)

Inward shift in demand	Internalizing a positive externality
Internalizing a negative externality	Outward shift in supply

6. Which of the following, if any, in the table below will likely result in fewer acres of farmland being subdivided and converted into residential, commercial, or industrial development? (circle any/all correct answers)

A new ¼ cent sales tax to fund the purchase of conservation easements	Stronger tax rebates (benefits) for ag. land enrolled in Williamson Act contracts
A new law making it easier for owners of agricultural land to subdivide and develop	Cheap farm imports drive farmers’ profits below zero

7. True/False (circle one): In general, an increase in overall demand for recycled materials will reduce the equilibrium price of recycled materials, thereby making it more difficult to cover the costs of recycling in rural areas with higher transportation costs.

8. True/False (circle one): PG&E strongly supported the deregulation of California’s electricity system in the mid-1990’s so it could purchase relatively inexpensive wholesale electricity and re-sell it at higher fixed retail prices to consumers.

9. True/False (circle one): Additional recycling of low-value high-volume materials by recycling centers in remote rural areas could be accomplished if the California Integrated Waste Management Board provided subsidies to offset the higher cost of transporting these recycled materials to large metropolitan markets.

10. True/False (circle one): Enron and other energy traders were able to “game” the California energy markets under deregulation because of California’s extensive use of long-term contracts with fixed prices at that time, and because of a substantial excess supply of surplus electricity generation capacity that was available during periods of peak demand.

11. True/False (circle one): Deregulation in California created a spot market for electric power purchases, and required utilities like PG&E to sell off some of their generating facilities in order to create a number of independent electric power sellers. Market manipulation caused wholesale prices to rise above fixed retail prices, resulting in PG&E’s bankruptcy.

12. True/False (circle one): In well-functioning competitive markets for storable non-renewable resources, if sellers anticipate future demand will rise substantially, sellers will reduce current sales quantities and increase future sales quantities. This will bring current and future prices into balance.

13. True/False (circle one): In well-functioning competitive markets for non-renewable resources with steady-state demand, constant marginal extraction costs, and positive discount rates, resource prices will steadily decline over time.

14. True/False (circle one): If there are three policy options for managing a parcel of National Park land, then the opportunity cost of the preferred option is the value of the next best alternative that must be given up if the preferred option is selected.

15. True/False (circle one): Scarcity means that an allocation choice must be made, and that an opportunity cost must be incurred.

16. True/False (circle one): A public policy that is Pareto efficient implies that while some people are worse off, and perhaps some are unaffected, nobody is made better off by the policy.

17. True/False (circle one): Internalizing negative externalities may not immediately eliminate pollution generated by the market, but it generally results in fewer emissions, and will help “level the playing field” and improve the market viability of costly, less-polluting alternatives over time.

18. True/False (circle one): When positive externalities are internalized in a well-functioning, competitive market, price reflects the social benefits of the good being bought and sold, and not just the private benefits.

Part 4: All students. 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. Recyclable natural resources	19. _I_ The value of the best option that has to be given up when a choice is made in the context of scarcity.
B. State (government) property	20. _Q_ The concept underlying deontological ethics.
C. Usufructuary rights	21. _H_ A policy that internalizes negative externalities.
D. Kaldor-Hicks efficient	22. _J_ This efficiency criterion is satisfied when a policy option increases net social utility and makes nobody worse off.
E. Tragedy of the commons	23. _R_ The gap between price and marginal cost that occurs in competitive commodity markets due to resource scarcity.
F. Positive externality	24. _N_ Occurs when price is above equilibrium in a well-functioning competitive market.
G. Buy too much	25. _F_ An external benefit generated from production and exchange and enjoyed without payment by members of society.
H. Pigouvian tax	26. _M_ According to Locke, un-owned land becomes your property when, by “improving” the land, you mix it with this.
I. Opportunity cost	27. _G_ Consumers do this in markets suffering from unresolved negative externalities because price reflects marginal private cost rather than marginal social cost.
J. Pareto efficient	28. _A_ These often have secondary markets where previously used resource competes with "virgin" resource.
K. Common property	29. _K_ The property rights regime in which the rights of access, withdrawal, management, and exclusion are held in common by a group of proprietors.
L. Law of diminishing marginal returns	30. _B_ The property rights regime that describes the ownership of Clam Beach County Park.
M. Your labor	31. _C_ Certain use and withdrawal rights to property that is owned by others.
N. Excess supply	32. _O_ Measure of market inefficiency that represents lost (or negative) gains from trade when quantity is too big or small.
O. Deadweight (social) loss	33. _E_ Occurs in a common-pool resource under open access conditions due to self-interested appropriators.
P. Consequentialism	34. _V_ Internalizes positive externalities by purchasing development rights.
Q. Categorical imperative	35. _L_ Occurs in the short run when the marginal productivity of a variable input declines.
R. Marginal profit
S. High discount rates
T. Demand curve
U. Zoning
V. Conservation easement