Economics 423 Examination 1 Fall 2004 Prof. Hackett KEY

Please provide the very best answer to any 10 of the questions below. Boldly cross out the question you do not wish to be graded. If you fail to cross out a question, I’ll randomly select a question to delete:

1. Briefly list (as bullet points) the positive externalities provided by forested watersheds:

• Reduced erosion and land movement
• Reduced sedimentation of fish spawning streams and rivers
• Reduced likelihood of severe flooding events downstream
• Habitat for forest-dwelling non-commercial species of plants and animals that the public cares about
• Potential public recreation site
• Gas exchange: production of O₂, sequestration of CO₂

2. Imagine a setting in which land owners have the necessary property rights to commercially harvest forested watersheds as they see fit. Briefly list (as bullet points) the public policy tools that can be used to internalize the positive externalities associated with forested watersheds and thus promote socially optimal timber harvest methods.

Note: If landowners have the right to harvest as they see fit, then no “public trust resource” property right exists, which implies that government cannot use regulatory tools like Pigouvian taxes or CDF harvest practice rules. What public policy tools are left are the “carrot” incentives of:

• Subsidies provided by government for practicing socially optimal forestry methods
• Conservation easements, where conservation groups or the government buys the landowner’s right to engage in excessive harvest
• Purchase of the land by conservation groups or the government, such as the Arcata Community Forest
• Eco-labeling systems (such as FSC) and higher prices paid by “environmentally conscious” consumers for labeled forest products

3. Imagine instead that members of society are recognized as having property rights to the positive externalities provided by forested watersheds, and that the state or federal government serves as proprietor of those “public trust resources.” Briefly list (as bullet points) the public policy tools that can be used here to internalize the positive externalities associated with forested watersheds and thus promote socially optimal timber harvest methods.

Note: Now that the public is acknowledged to have a property right to the external benefits, government as the proprietor of these “public trust” resources can use all the tools listed in question 2 above, PLUS the regulatory “stick” of:

• Pigouvian taxes on less than socially optimal forestry methods
• Regulatory standards for particular harvest methods

4. Suppose that the State of California is considering four different forestry management options (in addition to the status quo) for Jackson State Forest in Mendocino County. To keep the problem tractable, assume there are only five members of society that are affected by the management decision. The table below shows the level of utility or disutility that these five people experience for each of the proposed management options relative to the status quo.

Policy Options	Affected Members of Society					Net Social Utility
	Japhy	Yuri	Tristessa	Roland	Elly
Option 1	80	-20	-10	40	120	210
Option 2	50	0	20	-20	170	220
Option 3	0	5	15	30	60	110
Option 4	-20	60	0	-10	200	230

a. Compute the net social utility for each option and report it in the table above.

b. Which of the above options, if any, is Pareto efficient relative to the status quo? __3__

c. Which of the above options, if any, is Kaldor-Hicks efficient relative to the status quo? __4__

5. The question above makes the unrealistic assumption that a planner can measure and compare the level of utility or disutility to each member of society. Very briefly name two approaches that can be used to get people to reveal their preferences for the various policy options described above.

a. Voting, such as through propositions, initiatives, and ballot measures

b. Survey methods

Also, public meetings, non-market economic valuation methods

6. We discussed two broad categories of ethics in class, and related those to the economic problem of making good public policy choices in the context of scarcity.

a. Which of these ethical systems describes society’s duties toward individuals and the environment, based on shared values in that society?

Deontological ethics (or the categorical imperative)

b. If the society governed by this ethical system experiences increasing internal disagreement over these shared or dominant values, briefly list (as bullet points) the two broad ways that society may (re)organize in response to this increasing diversity?

a. Pooling. Potential for tyranny of the majority, which could lead to social unrest; also the potential for building social capital, finding common ground, and respecting diversity.

b. Separation into homogeneous subgroups.

7. [3 UNIT STUDENTS ONLY] Use the diagram below to show equilibrium price, quantity, consumer surplus, and producer surplus.

8. [3 UNIT STUDENTS ONLY] Draw a “social cost” supply curve and a “private cost” supply curve, and show the “socially optimal” and the “free market” equilibrium prices and quantities. Show marginal external cost and the deadweight social loss due to negative externalities in the “free market” equilibrium.

Consider the following supply/demand information:

Demand: p = 2000 – 1.5q

Private-cost supply: p = 200 + 0.5q

Social-cost supply: p = 600 + 0.5q (thus marginal external cost = $400)

7. [4 UNIT STUDENTS ONLY] Solve for the “free market” equilibrium price, quantity, and true net gains from trade. Show your work:

p* = $_______650_______

q* = _______900_______

True net gains from trade = $______450,000________

8. [4 UNIT STUDENTS ONLY] Solve for the “socially optimal” equilibrium price, quantity, and true net gains from trade, assuming that a Pigouvian tax is being used by regulators to internalize negative externalities.

p* = $_______950_______

q* = ______700________

True net gains from trade = $_______490,000_______

9. Suppose that a non-renewable resource is traded in a well-functioning competitive market over time. Suppose that demand and marginal production cost are the same in each year, and that the total quantity of resource available is less than would be needed to supply the competitive market equilibrium quantity in both time periods. Finally, suppose that the prevailing market discount rate (interest rate) is 20 percent. Use the diagrams below to show supply, demand, and an illustration of a dynamically efficient allocation of the resource in question. Show marginal profit (marginal Hotelling rent) in the two periods.

MC

10. Common-pool resources:

a. Carefully, briefly, and succinctly describe what happens to Hotelling rent in the Tragedy of the Commons, and why. Include in your answer the correct name for the externality at the heart of this problem.

Hotelling rent (or scarcity rent, or simply profit) is fully dissipated in the Tragedy of the Commons. Excessive harvest is driven by the appropriation externality (aka rule of capture externality in fishery CPR’s), namely that if some appropriators try to limit harvest in the current period (as in the first diagram in question 9 above), other appropriators will step in and harvest what has been left for the future. Knowing this, all appropriators harvest as much as possible now, which can result in destruction of the renewable (but depletable) resource.

b. Briefly list two examples of common-pool resources from Chapter 15 where local self-governance in the context of a common-property regime has prevented Tragedy of the Commons. In each case describe at least two of Elinor Ostrom’s design principles that are illustrated by the example.

Example 1: Swiss alps; utilize clearly defined boundaries and congruence between appropriation rules and local conditions, ….

Example 2: Panchayat forests; utilize clearly defined boundaries, collective choice arrangements, monitoring, ….

11. 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. Deadweight (social) loss	i. _S_ This is what is divided up by individual quota systems.
B. Circular externality	ii. _ P _ Example of an important local fishery that experiences derby conditions.
C. Pareto efficient	iii. _ L_ The name of the externality at the heart of the Tragedy of the Commons.
D. Kaldor-Hicks efficient	iv. _ K_ The property rights regime in which the rights of access, withdrawal, management, and exclusion are held in common by a group of proprietors.
E. Tragedy of the commons	v. _ R_ The gap between price and marginal cost that occurs in competitive commodity markets due to an inadequate quantity of a nonrenewable resource.
F. Producer’s surplus	vi. _ N_ Occurs when price is above equilibrium in a well-functioning competitive market.
G. Buy too much	vii. _ F_ The share of the total gains from trade that flow to sellers.
H. Individual fishing quotas	viii. _ I (or E)_ Occurs when fishermen lack property rights to a share of the total catch.
I. Derby conditions in a fishery	ix. _ G_ Consumers do this in markets suffering from unresolved negative externalities because price only reflects marginal private cost.
J. Usufructuary rights	x. _ H_ Management tool in a public trust fishery resource that eliminates the incentive to race for fish.
K. Common property
L. Appropriation externality
M. Open access
N. Excess supply
O. Opportunity cost
P. Dungeness crab
Q. Categorical imperative
R. Marginal Hotelling rent (or marginal profit)
S. Total allowable catch