ECON 423: Environmental and Natural Resources Economics

Old Midterm Exams

Economics 423, Midterm Examination #1, Spring 2000 Ð Professor Hackett

 

Name: _________________________________ (4 points)

There are seven questions on this examination. Please select any six to answer, and clearly cross out the one that you do not want me to grade. Each question you answer will be worth a maximum of 16 points.

1. Drawing upon your own interests, (a) make up a very brief, simple example of a situation involving ecosystems, natural resources, or the environment clearly illustrating that scarcity, and thus economics, applies beyond commercial market activity. (b) Briefly explain the concept of opportunity cost, and use your example to illustrate.

a. Water in the Eel river is scarce because there are more uses for it than is available at a zero price, such as the current issue of diversion of river water for irrigation, urban drinking water, and recreation in Sonoma County, which reduces in-stream flows needed for salmonids.

b. Opportunity cost is the net value of the best alternative to the current allocation. Thus the opportunity cost of diverting water for Sonoma county is the forfeited value of in-stream flows on the Eel needed for restoring salmonids.

2.Using your example in question 1 above, (a) briefly but succinctly describe how different value systems lead to a different ranking of alternatives and thus different rational economic choices. (b) If "economy vs. environment" is used in the popular media to characterize a choice in which both alternatives have economic value, what is the true basis of conflict?

a. Among Humboldt County residents it is likely that eliminating the Eel river diversion yields larger net social benefits than the status-quo, and thus is utilitarian-ethical from the Humboldt County point of view, while among Sonoma County residents the opposite is likely to be true.

b. If both sides have economic value (ex: in-stream flows and salmonid restoration vs. agricultural irrigation) then the true basis of conflict is the difference in preferences and values and circumstances.

3. (a) Is a policy choice that is ethical from a utilitarian perspective always Pareto efficient? Briefly explain why or why not with a very brief illustrative example. In answering this question, be sure to demonstrate your understanding of Pareto efficiency. (b) If a well-functioning competitive market is in equilibrium, is voluntary exchange between buyers and sellers Pareto efficient compared to the status quo of no trade? Briefly explain why or why not.

a. No. Utilitarianism states that the ethical policy yields the largest net social utility, in which case some may be made worse off. An example would be taxing the 10 richest people in the U.S. to fund environmental restoration and end poverty. Pareto efficiency requires not only that net social utility be increased, but that nobody be made worse off.

b. A well-functioning competitive market in equilibrium is Pareto efficient because all market participants receive gains from trade (consumer or producer surplus) that they would not have received if they had not traded.

4. (a) Define a negative externality. (b) Provide one clear example of a negative externality. (c) Briefly explain how negative externalities distort otherwise well-functioning competitive markets and lead to market failure. (d) Briefly describe one type of government policy intervention that might resolve the market failure due to negative externalities.

a. An uncompensated cost imposed upon "third parties" (society and the environment) that occurs as a side-effect of market or other exchanges.

b. Pollution (sulfur dioxide, oxides of nitrogen, carbon dioxide, etc) emitted by coal-fired electric generating facilities.

c. Firms supply along a private-cost supply curve rather than the social-cost supply curve, implying that market supply is overstated, market price is too low, and too much of the good or service (ex: electricity) is produced and consumed.

d. A Pigouvian tax equal to marginal external cost.

5. Suppose that commercial timber land generates positive externalities by also being habitat for a non-game endangered species. (a) Briefly explain how market systems answer the question of "what to produce" and use this to answer why markets will not adequately supply endangered species habitat. (b) Using a property rights and ownership argument, briefly explain why traditional common law would be inadequate to protect the endangered species. (c) If the private property rights held by the landowner extend to the habitat of the endangered species, what economic strategy or contractual mechanism is available for concerned individuals to protect the endangered species? (d) When fully implemented, how does the Endangered Species Act change the property rights held by the landowner in part "c" above?

a. Markets answer the "what to produce" question by producing what market demand tells them to produce (consumer soverignty). Markets will not adequately supply endangered species or their habitat because they are external benefits and thus are enjoyed without being paid-for, and thus are undersupplied in markets.

b. The land owner has the various property rights associated with private ownership, including the right to withdraw timber and impair habitat. Concerned individuals cannot use the common law to sue for damages because the common law only protects life and property, endangered species are not recognized as the property of those who care about them, and the habitat is the property of the landowner.

c. If the land owner cannot be forced to protect the habitat because she has ownership rights on the land, then concerned individuals can unite to purchase a conservation easement on the land, or get government to offer tax subsidies for habitat provision on private land.

d. When fully implemented, the ESA essentially takes some ownership rights away from the private individual as they pertain to the endangered species habitat, particularly those associated with withdrawal and management.

 

6. Suppose that in a well-functioning competitive market, demand is given by the equation P = 650 Ð Q, and (private-cost) supply is given by the equation P = 150 + Q, where "P" is price and "Q" is market quantity of some good or service. (a) Compute the market equilibrium P and Q. (b) Compute the total gains from trade (consumer and producer surplus). Show your work.

a. 650-Q = 150+Q è 500 = 2Q, and thus Q = 250. Plug 250 in for Q in either the supply or the demand equation to get P = $400. 

b. Total gains from trade: Draw the diagram. Notice that consumer surplus is [$(650-400)*250]/2 = $31,250. Likewise producer surplus is [$(400-150)*250]/2 = $31,250. Total surplus is $62,500. 

7. Suppose that production of each unit of output Q above leads to a marginal external cost of $100. If we integrate this marginal external cost into the market information in question 6 above, the equation for the social-cost supply curve is given by P = 250 + Q. (a) By how much is output in question 6 in excess of the socially efficient quantity, and by how much is price in question 6 below the socially efficient price? (b) Compute the $ amount of deadweight social loss from the market failure that occurs if society allows firms to continue to produce negative externalities as described above. Show your work.

 a. First compute the equilibrium price and quantity based on the demand in question 6 and the social-cost supply: 650-Q = 250+Q è 400 = 2Q, and thus Q = 200. Plug 200 in for Q in either the supply or the demand equation to get P = $450. Thus we can see that quantity in question 6 is too big by 50 units, while price in question 6 is too low by $50.

b. Deadweight loss is [marginal external cost * excess quantity]/2 = [$100 * 50]/2 = $2,500.