# homework2answer - Spring 2003 Solution Set to PS#2 When...

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1 Spring 2003 Solution Set to PS #2 When problem sets are corrected, if a mark S is made that means that you should refer to these “ S olutions” for more explanation. Total points: 100 Problem 1 (50 points) Part I (16 pts) Uncertainty about Demand Q is ecological services or area of the park. MC is the marginal cost of running the park or of displacing farmers. MB is the benefit of watershed protection to farmers, such as drought mitigation. We can think of taxes in this case more as consumer taxes on the farmers because they are the ones who benefit from the park. The positive externalities of the park to farmers can thus be captured and a tax in this case can be used to cover the costs of running the park. As in real life, alternative interpretations are possible such as producer subsidies to the provider of the park so that we can increase the quantity of the park (a public good.) Alternative interpretations of the problem are valid and will be given full credit. (a) Standard -- 3 pts for graph, 3 pts for calculation of DWL. Total 6 To calculate the DWL of the standard, we need to find first where the economy will be if it is regulated by a standard. First, if policy makers believe that MB is at MB L , then they will set the standard where MB L intersects MSC. This is point B in graph 1. Similarly, if policy makers use MB H , they will set the standard at the quantity corresponding to point C. The deadweight loss of being at point B, as opposed to the social optimum p. E, is triangle ABE (Note! Take the true MB curve to calculate DWL). Similarly the DWL of being at C is triangle CDE. We can calculate the area of these two triangles by taking the base of each times the height. To find the quantity at this intersection point, we equate the expressions for those two functions: MB L = MSC 10 + Q L = 80 – 5 Q L from this Q L = 10 Similarly Q H = 16.6 To find the actual MB for Q L and Q H acres of park, we need to find the corresponding price from MB T . Point A on the graph corresponds to MB T (Q L ) = 50 and point D – 16.66 E is at the intersection of MB T and MSC Q (at point E) = 13.3 Therefore AB = 50 – 30 = 20 The height is the vertical distance from p. E to AB = 13.3 – 10 =3.33 DWL L = 33. 3 Similarly DWL H = 33.3 EV (DWL) = .5 DWL H + .5DWL L = 33.33

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2 (b) Tax - 3 pts for graph, 3 pts for calculation of DWL Total 6 For tax regulation, it is important to remember that the policy makers set the price in the market and the actual quantity of acres demanded will be determined from the true MB curve. Therefore after we find the regulated price, we need to find the corresponding
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homework2answer - Spring 2003 Solution Set to PS#2 When...

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