Economics 423 Exam 1, Professor Steven Hackett, Fall 2008

Name (1 point): Answer Key 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.

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

1. a. Clearly draw a parallel social-cost supply curve in the diagram above, based on constant marginal external cost of $20. Note: Social cost supply curve will have a y-intercept value of $30.

1.b. Total external cost in the “free market” equilibrium in the diagram above is $200,000.

2. If a Pigouvian tax were used to internalize negative externalities in the diagram above, the new “socially optimal” equilibrium price = $70 and the equil. quantity = 8,000.

3. Pigouvian taxes make markets more efficient, as measured by an increase in the true net gains from trade. By how much are the true net gains from trade larger when negative externalities are internalized, relative to that of the free market equilibrium? $20,000

4. Now suppose that marginal external cost is a constant $50. In this case, the true net gains from trade in the “free market” equilibrium is $0.

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

Suppose that daily electricity demand is given by the equation P = 100 – 0.03Q

Private-cost electricity supply is given by the equation P = 20 + 0.02Q

Social-cost electricity supply is given by the equation P = 60 + 0.02Q

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 = $52 Q = 1,600 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 = $76 Q = 800 True net gains from trade = $16,000

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 = 60% Producer burden = 40%

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 decrease 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. True/False (circle one): CEQA is a “fair competition” law that makes it illegal for businesses to reduce their prices in order to capture a larger number of consumers.

7. True/False (circle one): In general, a decrease 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 and the other investor-owned electric generating utilities strongly opposed the deregulation of California’s electricity system in the mid-1990’s, as they knew that wholesale prices would rise above fixed retail prices paid by its customers, thereby causing them to become bankrupt.

9. True/False (circle one): Recycling low-value high-volume materials by recycling centers in remote rural areas would be more economically viable if local markets for the recycled materials could be developed, thereby reducing transportation costs.

10. True/False (circle one): Enron and other energy traders were able to “game” the California energy markets because the deregulation rules required the investor-owned utilities such as PG&E to buy electricity at “spot market” prices in the power exchange from independent power producers, and because there was very little excess generation capacity during times of peak load.

11. True/False (circle one): California’s AB 32 is a controversial new law that will reduce electricity prices in California by mandating the construction of many new coal-fired power plants and eliminating costly renewable energy and energy efficiency programs.

12. True/False (circle one): In well-functioning competitive markets for storable non-renewable resources, steadily increasing demand and high discount rates will result in resource prices falling at an increasing rate over time.

13. True/False (circle one): In well-functioning competitive markets for non-renewable resources with a fixed total stock, steady-state demand, constant marginal extraction costs, and positive discount rates, the quantity of the resource sold in period 0 will be larger than in period 1.

14. True/False (circle one): If there are five policy options for managing a parcel of National Park land, then the opportunity cost of the preferred option is found by adding up the value of the other four options.

15. True/False (circle one): Scarcity (in some form or another) is a fundamental condition faced by people across different times, places, cultures, and economic systems.

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

17. True/False (circle one): Internalizing negative externalities may not immediately eliminate all 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 the equilibrium quantity of the good generating the positive externalities increases.

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_ Under CEQA, new commercial development that results in this can have a significant environmental impact.
B. State (government) property	20. _P_ The concept underlying teleological ethics.
C. Common property	21. _L_ Occurs in the short run when the marginal productivity of a variable input declines.
D. Kaldor-Hicks efficient	22. _D_ This efficiency criterion is satisfied when a policy option makes net social benefit as large as possible, even if some are made worse off.
E. Marginal cost curve	23. _B_ The property rights regime that describes the ownership of Patrick’s Point State Park.
F. Positive externality	24. _N_ Requires a portion of the electricity sold by utilities like PG&E to derive from renewable sources.
G. Equilibrium quantity is too small	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. Blight (physical deterioration)	27. _G_ This occurs in markets suffering from unresolved positive externalities because demand is based on private benefits rather than social benefits.
J. Pareto efficient	28. _A_ These often have secondary markets where previously used resource competes with "virgin" resource.
K. Common property	29. _T_ This shows the relationship between price and quantity demanded on a diagram.
L. Law of diminishing marginal returns	30. _R_ Hotelling’s rule is satisfied when this is equal in all time periods.
M. Your labor	31. _C or K_ This property rights regime describes the ownership of Swiss alpine meadows.
N. Renewable portfolio standard	32. _O_ A 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_ This is also the supply curve for firms in a competitive market.
P. Consequentialism	34. _V_ Policy tool that internalizes positive externalities by purchasing development rights.
Q. Categorical imperative	35. _H_ A policy that internalizes negative externalities.
R. PV Marginal profit
S. High discount rates
T. Demand curve
U. Zoning
V. Conservation easement