Economics 423 Mid-Term Examination 1, Fall 2003, Professor Steven Hackett

Your name: ____________KEY___________________

Please provide the very best answer to each of the questions below.

Part I: Matching (4 points each). Please connect the description on the right side of the table below with the best-matching word or phrase on the left side of the table. There is only one match for each phrase, and there are extra words or phrases.

Word or Phrase	Match	Description
A. Marginal private cost	A	1. The cost to the firm of producing an additional unit of output. Does not include external cost.
B. Law of Diminishing Marginal Returns	D	2. Negative or foregone gains from trade that occur as a consequence of most market failures.
C. Economic rationality	O	3. The core concept that underlies teleological systems of ethics such as utilitarianism.
D. Deadweight social loss	H	4. A real-world policy tool that can internalize the positive externalities associated with agricultural lands.
E. Pigouvian tax > cost of eliminating emissions	B	5. Explains that in the short run as you add more and more of a variable input to a fixed input, eventually the marginal productivity of the variable input will decline.
F. Categorical imperative	K	6. Quantity supplied exceeds quantity demanded.
G. Pigouvian tax < cost of eliminating emissions	P	7. Ownership of something by a group of people, as opposed to ownership by an individual or ownership by government.
H. Conservation easement	J	8. This describes equilibrium quantity if markets feature substantial unresolved positive externalities.
I. Excess demand (shortage)	R	9. The value of the best alternative that is given up when an economic choice is made.
J. Equilibrium quantity is less than socially optimal	C	10. As the term is used in this course, it occurs when one's choices are consistent with one's values or preferences. Thus if you know preferences you can predict choices.
K. Excess supply (surplus)	F	11. Developed by Kant, this is the core idea that underlies deontological ethics.
L. Kaldor-Hicks efficient	E	12. When this is true, taxing pollution emissions will cause profit-maximizing firms to change to a non-polluting form of production.
M. Consumer surplus	I	13. Quantity demanded exceeds quantity supplied.
N. Usufructuary rights	N	14. Bundle of use and withdrawal rights.
O. Consequentialism	M	15. Measures (willingness-to-pay minus price)
P. Common property
Q. Pareto efficient
R. Opportunity cost

Part II: Analysis (5 points each)

Use the following information for the next five questions. Suppose that in a well-functioning competitive market, demand is given by the equation P = 1050 - 0.5Q, private-cost supply is given by the equation P = 50 + 0.5Q, marginal external cost is $200, and social-cost supply is given by the equation P = 250 + 0.5Q.

1. Solve for the equilibrium price and quantity if firms are allowed to freely pollute. Show your work.

1050-0.5Q = 50+0.5Q

Q=1000 P* = $____550______ Q* = _____1000______

P = 50+.5(1000) = $550

2. Calculate the true net gains from trade from question 1 above (consumer and producer surplus that market participants receive minus total external cost). Show your work.

$(1050-50)x1000/2 - $200x1000 = $300,000

True net gains from trade = $______300,000_____

3. Solve for the equilibrium price and quantity if a Pigouvian tax is imposed. Show your work.

1050-0.5Q = 250+0.5Q

Q=800 P* = $____650______ Q* = _____800______

P = 250+0.5(800) = $650

4. Calculate the true net gains from trade with a Pigouvian tax (assume that the tax revenues are used to compensate those harmed by pollution, or to clean up). Show your work.

$(1050-250)x800/2 = $320,000

True net gains from trade = $_______320,000____

5. By how much is welfare (as measured by gains from trade) enhanced by the use of a Pigouvian tax (subtract the correct answer to question 2 above from the correct answer to question 4. above). Show your work.

$320,000 - $300,000 = $20,000

Welfare enhancement = $______20,000_______

Part III: Fill in the Blank (3 points per blank)

1. Scarcity implies that we must make economic choices. The value of the best alternative that must be given up when a choice is made is called _______opportunity cost________.

2. The three economic questions that all societies must answer are _____what______ to produce, _____how______ to produce, and ______for whom________ to produce.

3. Marginal ______external_____ cost measures damages to health and the natural world (e.g., particulate matter) that come about from producing one more unit of output (e.g., generating an additional kilowatt hour of electricity).