Economics 423, Midterm Examination #2, Fall 2003 – Professor Hackett 

Name: ____________KEY_____________________

Please provide the very best answer to each of the questions below (Answers in blue font)

PART I: Fill in the blanks (3 points per question, 20 questions, 60 points total)

1. In an individual quota system fishermen are each given a share of total allowable catch, which eliminates the rule of capture externality.

2. In the case of scarce nonrenewable natural resources, the higher the discount rate the more rapidly price rises over time, because the quantity allocated for consumption is relatively large in the current period but becomes successively smaller in future periods.

3. Effort is the term used in fishery economics for the capital and labor inputs applied to fishing, and can be measured in units such as "vessel days".

4. Garrett Hardin coined the term tragedy of the commons, which refers to depletion of common-pool resources due to overuse or excessive harvest rates.

5. A common pool resource has the characteristics of rivalry in consumption and subtractability, while common property is an ownership regime in which a group of proprietors collectively govern a natural or constructed resource, as described by Elinor Ostrom.

6. Economically valuable ecosystem services that are provided "for free" by nature, such as air and water purification, decomposition of wastes, and renewal of soil fertility, represent the beneficial flow from the stock of natural capital.

7. If marginal benefits are positive, then we know that total benefits are still increasing.

8. If a job is similar to many others but (i) involves an annual risk of premature death on the job that is 0.0002 (2 per 10,000) higher, and (ii) pays a wage premium of $675 per year, then the value of a statistical life is $ 3,375,000.

9. The travel cost method can be used to measure the non-market recreational use value of wilderness areas and wild rivers. This method cannot measure non-use value.

10. The contingent valuation method can be used to measure non-use values (e.g., existence or option values) for aspects of the environment or for natural resources.

11. The hedonic regression method can be used to measure the value of environmental amenities that are bundled together with something that is traded in markets, such as views, air quality, and access to parks associated with residential housing.

12. Higher prices caused by increased market concentration caused by higher fixed costs, and reduced rates of economic growth caused by investment in anti-pollution equipment, are examples of indirect costs, while the expenses from using pollution control devices and hiring environmental compliance employees are examples of direct costs.

13. In Keohane’s political economy model the demand for effective regulatory policy support derives from the willingness-to-pay by interest groups that support that policy, while the supply of effective regulatory policy support reflects the various opportunity costs of the policy maker(s).

14. Duverger’s Law, which is linked to the median voter theorem, states that winner-takes-all plurality (or simple majority) voting systems will result in 2 dominant political parties, a situation in which third parties are spoilers.

15. When firms that violate environmental law are at risk of being caught, deterrence is created when the expected penalty exceeds the benefits associated with violating environmental or natural resource law for risk-neutral firms or people.

16. Reputational enforcement is more likely to work when consumers are well informed of (and care about) a firm's environmental performance, when quality substitutes are available, when boycotts are easy to organize, and when boycotts (or increased sales for the environmentally friendlier firm) significantly affect a firm's current and future profitability.

17. When state environmental or natural resource law is violated, prosecution is usually handled by the county District Attorney's office, though the state Attorney General's office may also help in the prosecution.

18. When the U.S. EPA wishes to go beyond administrative penalties and pursue civil or criminal prosecution of alleged environmental law violators, it usually refers such cases to the Department of Justice.

19. Command and control regulations (e.g., catalytic converters on cars) directly regulate emissions, while incentive regulations (e.g., pollution taxes) work indirectly to regulate emissions.

20. The EPA's Acid Rain program is an example of a cap-and-trade system. In the context of a substantial reduction in sulfur dioxide emissions, this program substantially reduced compliance costs to firms.

PART II. Computational analysis (8 questions. Please answer any 5 of the questions below. Clearly cross out the 3 you will not answer with a BIG X across the whole question. Each question you do answer is worth 8 points, for a total of 40 points)

1. Suppose that there are 2000 units of a nonrenewable resource available over two periods (0 and 1). Demand in each period is given by P = 4000 - Q. Marginal cost is a constant 400 in both periods. The discount rate is 30 percent.

What is the dynamically efficient allocation of the 2000 units of the nonrenewable resource, and what will be the prices in the two periods? (within $50 of satisfying Hotelling's rule; show your work)

Q₀ = ____1,339.13_____ P₀ = _____2,660.87____

Q₁ = ____660.87_____ P₁ = ____3,339.13_____

To see how to do this, go to the PowerPoint slide show for Chapter 5 of the Hackett textbook at http://www.humboldt.edu/~envecon/ppt/E423pptch5.ppt

2. In order for the dynamically efficient solution to question 1 above to yield an equal division of the resource over time, what would the discount rate need to be? (1/2 credit for answer, 1/2 credit for proving your answer using Hotelling’s rule)

P₀ = 4000 - 1000 = 3000. (P₀ - MC) = 3000 - 400 = $2,600.

P₁ = 4000 - 1000 = 3000. (P₁ - MC)/(1+0)¹ = 3000 - 400 = $2,600.

Discount rate = ____0____ percent

3. In reference to the problem in question 1 above, suppose the basic setup of the problem stayed the same except that the total available resource stock were different. In particular, which of the total resource stocks below will cause both P₀ and P₁ to increase relative to the correct answer to question 1? Circle one:

Total resource stock = 1000 2000 3000 4000 5000 6000

4. Suppose that marginal benefit from reducing emissions is given by the equation MB = 100 - Z, and marginal cost from reducing emissions is given by the equation MC = Z. Note that "Z" is the percentage of total emissions to be reduced. Solve for the percentage of total emissions reduced that maximizes total net benefits. Please show your work.

The level of Z that maximizes total net benefits occurs were MB = MC ==> 100 - Z = Z ==> Z = 50 percent.

5. Suppose that a risk-neutral petroleum refinery can save $10 million per year in compliance costs by not complying with environmental regulations. Suppose that the probability of the infraction being detected by field monitors is 50 percent, and that the probability of a judge imposing the statutory penalty given detection is 80 percent. If the statutory penalty calls for a fine equal to double the annual cost savings gained by the offender, then will this system create deterrence? Show your work.

0.5 x 0.8 x $20 million = $8 million < $10 million in cost savings from being out of compliance ==> no deterrence.

6. Given the information in question 5 above, what is the minimum statutory penalty that would be just sufficient to create deterrence for this risk-neutral firm? Show your work.

0.5 x 0.8 x ? = $10 million; ? = $10 million/0.4 = $25 million. Add a smidgen of extra $$ to create deterrence....

7. How would your answer to question 6 above change if the probability of being detected by field monitors were to increase to 70 percent? Show your work.

0.7 x 0.8 x ? = $10 million; ? = $10 million/0.56 = $17.86 million. Add a smidgen of extra $$ to create deterrence....

8. The data in the table below refers to pollution emissions and marginal pollution abatement cost per ton in an industry. Total industry-wide emissions are to be reduced by 50 percent (2400 tons/year):

Firms	Historical Emissions (Tons/Yr)	Marginal Abatement Cost ($/Ton)	Allowances Bought	Allowances Sold	Total Abatement Cost (No Tradable Allowances)	Total Abatement Cost (Tradable Allowances)
Alkyone	600	100		300	30,000	60,000
Merope	600	300		300	90,000	180,000
Kelaino	600	500		300	150,000	300,000
Elektra	600	700		300	210,000	420,000
Sterope	800	900	400		360,000
Taygete	800	1100	400		440,000
Maia	800	1300	400		520,000
TOTAL	4800	---	1200	1200	1,800,000	960,000

a. Suppose that the regulatory target of cutting total emissions by 50 percent is accomplished with a command-and-control regulatory system that requires each firm to cut its emissions by 50 percent. Correctly fill in the "total abatement cost" column for "no tradable allowances" in the table above.

b. Now suppose that the regulatory target of cutting total emissions by 50 percent is accomplished by allowing each firm to emit only 50 percent of its historical emissions. These allowances are fully tradable. Correctly fill in the "allowances bought", "allowances sold", and "total abatement cost, tradable allowances" columns in the table above.