Quiz 2, Economics 423, Fall 2007 (Prof. Hackett)

Name: ANSWER KEY Pick ONE question you do not want me to grade and cross it out with a big “X”. Provide the very best answer to each of the remaining 11. All questions are equally weighted and worth the same number of points.

Part I: All students

1. True or false (circle one): If a job is similar to many others but (i) involves an annual risk of premature death on the job that is 0.00008 (8 per 100,000) higher, and (ii) pays a wage premium of $480 per year, then based on this data, the value of a statistical life is $6 million.

2. True or false (circle one): In the absence of individual quotas, fishery management utilizing a total allowable catch and season openings can induce a race for fish, or derby.

3. True or false (circle one): When individual quotas are instituted in a heavily depleted commercial fishery suffering from overcapitalization, allowing these quotas to be tradable will tend to reduce overcapitalization by giving some fishers an incentive to sell their quota and leave the fishery.

4. True or false (circle one): In the benefit/cost analysis done by the California Energy Commission regarding removal of the Klamath River dams, the costs include the present value of estimated expenditures to remove the dams and provide alternative sources of electricity for those who had been buying hydroelectric power from these dams.

5. True or false (circle one): Nonuse values (such as existence value) can be estimated from a survey of visitors using the travel cost method.

6. True or false (circle one): The demand for a particular piece of legislation derives from the opportunity cost of the legislator’s time, the legislator’s personal preferences, and how support for the legislation affects the legislator’s prospects for re-election.

7. True or false (circle one): Results from the median voter theorem explain why politicians tend to gravitate away from the political center, where most of the voters are located, and closer to the extreme positions of their respective political parties.

8. True or false (circle one): Duverger’s law states that a winner-takes-all election system will result in an elimination of the two party system and instead promote a large number of small independent political parties that will band together to create a coalition government.

9. True or false (circle one): Economically valuable ecosystem services, such as air and water purification, decomposition of wastes, and renewal of soil fertility, represent the beneficial flow from the stock of natural capital.

Part II: ONLY For students in the 4^th unit lab:

Suppose that there are 1000 units of a nonrenewable resource available over two periods (0 and 1). Demand in each period is given by P = 2000 - Q. Marginal cost is a constant 400 in both periods. The discount rate is 10 percent.

10. What is the dynamically efficient allocation of the 1000 units of the nonrenewable resource, and what will be the prices in the two periods? Please show your work.

Q₀ = 552.38 P₀ = $ 1,447.62

Q₁ = 447.62 P₁ = $ 1,552.38

11. Suppose that the basic setup of the problem above were the same, except that now the discount rate rises to 20 percent. Re-compute the dynamically efficient allocation of the 1000 units of the nonrenewable resource. Please show your work.

Q₀ = 600 P₀ = $ 1,400

Q₁ = 400 P₁ = $ 1,600

12. Correctly draw the price paths for questions 1 and 2 above in a single fully-labeled diagram. Provide a brief economic explanation for why the two price paths have different slopes.

Put price on the “y” axis and “time” on the “x” axis. Show the two prices from answer 10, connected together with a line, and the two prices from answer 11, likewise connected by a line. Show that the price path from the answer to question 11 is steeper. Note that it is steeper because the higher discount rate requires a larger allocation to the present, leaving less for the future, relative to the lower discount rate. The higher the discount rate the less important are future gains relative to current gains.

Part III. ONLY For students who are NOT in the 4^th unit lab.

.

Suppose there are four fishers working a fishery. An individual fisher’s share of group profit is equal to the percentage of total effort that she provided. Use the above table to derive the following:

10. Suppose the fishers agree to each provide 2 units of effort (e.g., 2 fishing trips each) in order to achieve the maximum level of group profit for a fishery. How much profit would each individual fisher receive if each of the four provides 2 units of effort, as they agreed (total effort = 8)? Show your work.

The group optimal effort is 8. Each individual fisher sets effort at 2, and each individual fisher gets ¼ of total group profit of $1,400.

Individual fisher’s profit at group optimum = $ 1,400/4 = $350

11. Suppose one of the fishers decides to cheat on this agreement and provide 6 units of effort, while the other 3 continue to provide 2 units of effort each. How much profit would the cheater receive if she provides 6 units of effort, while the other three fishers continue to provide 2 units of effort each (total effort = 12)? Show your work.

The cheater sets effort at 6, or ½ of total effort. Cheater’s gain is ½ of the total group gain of $900 that occurs when effort = 12.

Cheater’s profit = $450

12. How much profit would each of the three individual non-cheaters receive if they continue to provide 2 units of effort, while the cheater provides 6 units of effort (total effort = 12)? Show your work.

The 3 non-cheaters each continue to provide 2 units of effort. The three non-cheaters thus split the other half of the group profit not captured by the cheater, thus, giving each individual $450/3 or $150.

Individual non-cheater’s profit = $150

Briefly explain in words how this example relates to the incentive to over-fish and perhaps lead to tragedy of the commons.

The group-optimal effort level is fragile in that, like a cartel, there is an incentive for fishers to cheat and provide more effort than they agreed to provide. Achieving the group optimal agreement requires durable social institutions, social capital, and monitoring and enforcement activies.