solution_PS2_spring2006 - EEP101/ECON125 Spring 2006...

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EEP101/ECON125 Spring 2006 Problem Set 2 (Due Thursday, March 2 in class) We encourage you to work together, but each person must submit his/ her own responses. PLEASE WRITE YOUR NAME, SID, AND SECTION NUMBER ON EACH PAGE. Question 1 True, false, or uncertain. Please answer and provide a SHORT explanation. (Please correct in a meaningful way if false, not just by adding the word “not.”) a) If a policy maker is uncertain about the true demand curve, a tax is a preferred policy tool. Uncertain: It depends on the elasticity of demand. Only if demand is inelastic, would a tax be a preferred policy tool, as the outcome will be closer to the targeted optimal outcome. If demand is elastic however, a standard or quota would be preferred as it would be closer to the optimal outcome. b) The Coase theorem tells us that there is no reason to regulate externalities as long as property rights are clearly defined. False: In order to invoke the Coase theorem, we also need two additional assumptions (full information and zero transaction costs). Only under these three assumptions does the Coase theorem hold, which states that there is no need for intervention in cases of externalities as outcomes will be pareto optimal regardless of initial distribution of rights. Question 2 After listening to all the practical examples in class, you feel that it is time to go and employ what you learned in the real world. So you decide to quit university and become an orange farmer. You purchase a piece of land with beautiful orange trees, and now need to decide what technology to use to spray pesticide (x) against a common pest, the Asian citrus leafminer. You inherited a contract for aerial spaying (I=0) when buying the land, but could invest in precision applicators instead (I=1). Assume that the cost of the pesticide and the relevant technology used are your only relevant input costs at this time and that the wholesale price for a pound of oranges is constant at $.50 cent due to a marketing order. The aerial application (K 0 ) comes at no extra cost, while the precision application (K 1 ) would require an additional investment of $150. Residue from pesticide application contaminates groundwater. As a result, a tax might be imposed on orange
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This note was uploaded on 08/01/2008 for the course ECON 101 taught by Professor Wood during the Spring '07 term at Berkeley.

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solution_PS2_spring2006 - EEP101/ECON125 Spring 2006...

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