PRELIM 2 ECON 335  Cornell University 
J. Wissink – Spring 2008 – April 9
Directions:
Write legibly, concisely, & coherently. Label all axes, functions, & variables you use. READ
QUESTIONS CAREFULLY. Draw pictures whenever possible.
MAKE SURE YOU DO ALL PARTS OF
EACH QUESTION.
Total time for the test is 75 minutes. Total points on exam = 100.
__________________________________________________________________________________
1.
(10 pts)
Consider the market for pulp&paper (which is a very stinky industry).
Suppose that the
(inverse) market demand curve is given by P
D
= 46  2X, where X is the number of units demanded.
Suppose that the (inverse) market supply curve is completely elastic and given by P
S
= $10.
Suppose
that for each unit of X produced, a constant marginal external cost of $6 is imposed on people who live
external
= $6.
a.
In the absence of any government intervention, how much X is produced?
b.
What is the Pareto efficient level of production of X?
c.
What is the $value of deadweight loss if society ignores this externality situation?
d.
Calculate a Pigouvian tax that would lead to the efficient level of production.
e.
Does the Pigouvian tax lead to an actual Pareto improvement in this market?
Briefly, why or why
not?
2.
(12 pts)
Suppose you are writing a policy to deal with pollution reduction.
Suppose you are told that
the equation for the marginal cost of pollution reduction is:
MC = 2 + 10Q, where Q is the amount of
pollution reduction.
Suppose that you are uncertain about the marginal social benefit of pollution
reduction, but your best guess is the following:
MSB = 24 – Q.
What will work better, a cap and trade policy
or
an emissions fee policy, assuming that you determine
your policy based on your best guess of MSB and then AFTER YOU MAKE THE POLICY CHOICE
you discover that in actuality, MSB = 35 – Q?
Defend your position with either algebra or a good graph.
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 Spring '08
 WISSINK
 Supply And Demand, Betty, market supply curve, Abe, pollution reduction

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