ECON 423: Environmental and Natural Resources Economics

Old Midterm Exams

Econ 423 - Environmental and Natural Resources Economics

Exam 2

Fall 1997 (Prof. Hackett)


Please answer any 5 of the 6 questions below. Be sure to cross out the question you do NOT wish me to grade. Each question is worth 20 points.


1. Suppose that demand in each of two periods is given by P = 100 - 2Q, that marginal extraction cost for a nonrenewable, nonrecyclable resource is $10, that the discount rate is 10 percent, that the resource market is competitive, and that 90 units of the resource are available for consumption. In the dynamically efficient solution, the present discounted value (PDV) of marginal Hotelling rents are equalized across both periods. Derive the marginal Hotelling rent for period 0 for the dynamically efficient solution to the problem above. Show your work.

Under marginal cost pricing, in each of the two years the market quantity would be 45 units, which sums to the 90 units available for consumption in the two years. Thus the PDV of marginal Hotelling rent [PDV (P-mc)] = 0, and this is the dynamically efficient solution.

  1. a. Precisely describe the nature of the appropriation externality that forms the basis of the "tragedy of the commons."

An opportunistic appropriator who takes too much gets all the incremental benefit from excessive appropriation, but the resulting costs are shared among all the appropriators. This is the essence of Garrett Hardin's herder scenario that led to his Tragedy of the Commons result.

  1. b. For what types of resources is the privatization solution to the tragedy of the commons not feasible?

-Fugitive resources such as air, pelagic marine fisheries, ground water, and oil/gas deposits that cannot be fenced off or otherwise partitioned into privately owned units of stock.

-Those resources from which it is difficult to exclude others.

  1. c. List and briefly describe the eight characteristics of locally self-governed CPRs that Ostrom has found to be associated with sustainable common-property systems.

Clearly defined boundaries between private and common property

Rules for maintenance and appropriation that are based on local conditions (congruence)

Graduated sanctions - proportionate to the importance of the rule violation

Existence of effective mechanisms for resolving disputes among appropriators

Decisions are made in a democratic, collective-choice framework

The commons are actively monitored to assure compliance with rule systems

Central government authorities recognize the rights of local people to self-governance

Rule systems for interdependent resources are nested and interactive

Suppose you are a consultant hired to help an environmental policy maker interpret a benefit/cost study. The policy maker is being heavily pressured to change an important environmental regulation based solely on the numerical outcome of the benefit/cost study. List and briefly describe the arguments against using benefit/cost as the sole deciding factor in setting environmental policy.

The problem of dissimilar metrics - incommensurability

Rich and poor derive widely different marginal utilities from the purchasing power of a $1

What is the appropriate rate at which to discount $-impacts on future generations?

What is the appropriate way of monetizing the value of human lives saved?

If we do not fully understand ecosystem interactions, we cannot fully monetize impacts

  1. List and briefly describe the various reasons why a profit-maximizing firm might voluntarily overcomply with current environmental regulation.

To appease citizens and government, preventing more stringent regulation in the future

As a substitute for image advertising-reputation enhancement

To encourage regulation that might raise rivals' costs

To produce pollution allowances that can then be sold in marketable allowance programs

Reducing wastes may actually save money

Receive improved treatment by the EPA and other regulatory agencies (ex: ELP)

  1. List and briefly describe the various forms of environmental incentive regulation that governments have used. Your brief description should explain the desirable incentives that are fostered by the regulations that you list.

Take-back schemes: Creates an incentive for firms to make goods and packaging more easily reusable or recyclable

Deposit-return schemes: Creates an incentive to recycle glass and aluminum beverage containers

Pollution taxes: Creates an incentive for firms to reduce emissions, and for R&D in clean technology

Marketable allowance systems: Trading lowers the direct costs of regulatory compliance; creates an incentive for firms to exceed regulatory requirements and sell excess allowances

Subsidies: Promote alternative and appropriate technologies

Liability: Creates an incentive for due care to limit exposure to lawsuits

Property rights/secure land tenure: Creates an incentive for due care by creating a longer-term horizon

  1. Suppose that there are 10 firms, each of whom have historically been emitting 100 tons of particulate matter per year. Suppose further that each firm has the following marginal abatement cost (which are assumed to be constant to make this problem simple):

Firm A--$5/ton Firm B--$10/ton Firm C--$15/ton Firm D--$20/ton Firm E--$25/ton

Firm F--$30/ton Firm G--$35/ton Firm H--$40/ton Firm I--$45/ton Firm J--$50/ton
  1. a. Derive the industry-wide total abatement cost associated with a 50 percent reduction in emissions, assuming each firm must reduce emissions by 50 tons/year and assuming no allowances trading. Show your work.

$13, 750

  1. b. Derive the industry-wide total abatement cost associated with a 50 percent reduction in emissions, assuming each firm is given an allowance to emit 50 tons/year, and that these allowances are fully marketable. Show your work.

$7, 500

  1. c. Describe conditions under which it might be best to have limited allowances trading and to require all polluters to engage in at least some abatement.

Localized hot spots, which occur when emissions are not uniformly mixed

EXTRA CREDIT (5 points): "As nonrenewable, nonrecyclable resource becomes increasingly scarce, marginal Hotelling rents rise." Is this statement true or false? Provide a precise explanation to defend your answer.

True; marginal Hotelling rent (P-mc) rises; to see this, go back to question 1 above and reduce the available stock from 90 to 50; in this case the dynamically efficient allocation features marginal Hotelling rent in excess of $0.