Econ 428. Fall Answer Sheet Midterm 1

Transcription

1 Econ 428 Fall 2016 Answer Sheet Midterm 1 1. The statement is false. The statement is the condition for allocative efficiency for a private good when there are no cost externalities. In the case of a public good, since consumption is nonrival and nonexcludable, everyone in the affected group consumes each unit of the good produced. The MSB of an additional unit of output is the sum of the WTP of the additional unit of output over all people in the group. In the graph the MSB is the vertical sum of the WTP of all the individuals. Allocative efficiency requires that the MSB of the last unit equal the MC of the last unit, the additional benefit summed over all members of the group must equal the resource cost of the unit. The efficient output level is. All members of the group consume the same amount of the public good, but each has a different private marginal benefit from this consumption. $ MC WTP3 WTP2 WTP1 MSB QA Q of public good

2 2. The statement is false. A correct statement is: The Coase Theorem states that the presence of externalities, combined with poorly defined property rights, high transactions costs, or damages that cannot be quantified, will result in an allocatively inefficient amount of the good being produced. An explanation of this statement will include the following points. Inefficiency occurs when an externality is present and the two affected parties, the one creating the externality and the one affected by the externality, cannot bargain between themselves to internalize the effect. Bargaining will be difficult or impossible if there are high transactions costs, if the property right to the item creating the externality is not clearly defined, or if the damages caused by the externality are uncertain or cannot be measured. More precisely, Coase showed that, when bargaining is possible and the property right is given to the polluting party, there will be a gap between the value of the last unit of output/pollution to the polluter (MBPollution) and the damage done to the recipient (MEC) with MEC>MBPollution. The recipient can offer any price between MEC and MBPollution to the polluter to reduce production and it would be in the polluter s interest to accept. If the property right is given to the recipient of the pollution then MEC<MBPollution and the polluter will be able to offer a price between MEC and MBPollution to the recipient to buy the right to pollute. Either way, private bargaining resolves the externality problem and the allocatively efficient output level (MEC= MBPollution) is produced. 3. The statement is false. A correct statement is: When production of a good also creates a pollution externality, the allocatively efficient level of output will result in the total environmental cost being positive (TEC>0). An explanation of this statement will include the following points: allocative efficiency requires balancing (at the margin) the benefits to society from an extra unit of output with the costs to society of an extra unit of output (WTP=MSC). The latter includes both marginal production costs and environmental costs (MSC=MPC + MEC). The environmental damage caused by the last unit of output (MEC) is not zero, but rather is just balanced by the gain in surplus to producers and consumers. There will be environmental damage at the efficient output level. In the following picture (which assumes that MEC increases with Q), the allocatively efficient output level is Q E. The MEC of that last unit of output is the distance AB and this is just equal to the surplus earned by producers and consumers on that unit. The TEC of producing that output is the area ABC which is not zero.

3 MSC= MPC + MEC S = MPC PE A C D=MB QE 4. The wind turbines have blocked the views of Mount Adams and the county s stunning landscape and there is noise from the turbines. Hence the negative externalities involve visual and noise pollution. To compensate for the negative externalities, the wind companies distribute checks to the residents of the town. Every Sherman County head of household who has owned property for more than a year qualifies to receive money. Hence the property rights have been assigned to the citizens of the town and the wind companies compensate the citizens for the damage from the externality A corporation, Praise the Wind, negotiated leases, manages payments and acts as a liaison with the wind companies. This intermediate company represented the citizens and bargained with the wind company. This helped keep the transactions costs low which is an important criteria for the Coase Theorem to work. 5. A) The competitive market outcome equates private benefits and costs: 300 2Q = Q so that Q C = 20, P C =260 B) The condition for the allocatively efficient output level is WTP = MSC. WTP = 300 2Q MSC = MPC + MEC = (200 +3Q) + 25=225+3Q.

4 Q E = 15 C) TEC at Q C is the area DCEF and at Q E is the area DIGF. D) When there is a negatively externality, W = PS + CS TEC. This is true at every output level, Q C and Q E. At Q C, PS+ CS = area ACD = (1/2)(20)(100)=1000 TEC = area DCEF = 25(20)=500 W = AGF GEC = 500 At Q E,, PS + CS = area AGID = TEC = area DIGF = 375 W = AGF = The welfare gain of moving from Q C to Q E is the area GEC = ½(5)(25) = $62.5 It arises because the first 5 units output had a MSC>MPB. Total welfare improves when these units are not produced. E) A product tax could be used to make the battery producer face the MSC, rather than the MPC, of production. A tax equal to MEC at Q E would shift the producer s marginal private cost curve until it was equal to the MSC curve and the profit maximizing output level for the firm to produce would be Q E. The tax in this case would be $25.

5 6. In the discussion of water allocation to Prickly Pear Creek that we saw in the TED talks video which of the following statements is TRUE D. The use it or lose it provision of the original law helped contribute to the overuse problem. 7. Each mile that we drive our cars produces a negative externality for others because of the pollution and congestion we produce. Suppose individuals collectively drive Q miles. Which of the following statements correctly describes the relationship between benefits and costs at this level of total output. C. MSC > MPB 8. Which of the following statements about a public good is TRUE. B. The MSB curve of the public good is the vertical sum of the WTP curves across all consumers. 9. Which of the following statements about the article The Promise and Problems of Free Market Environmentalism, by Charles Kolstad is TRUE? E. A and D are true 10. Which of the following statements about allocative efficiency is FALSE? E. The Coase Theorem states that it is impossible to achieve the allocatively efficient level of output when a negative externality is present

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