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Unformatted text preview: rro + V,'l:0..l' a NO ECOAI '-11 Go Public Finance Midterm Exam Fall 2008 Answer THREE questions. Answer every bullet, show all work. 1. Adams Ale Co has drawn crystal clear drinking water from an adjacent stream for use in brewing its premium products for over one hundred years. Several years ago, Putrid Paper Corporation opened up a few miles upstream from Adams. Putrid's waste discharges degrade the quality ofthe water taken up by Adams, requiring additional costly filtration before use in brewing. Because Adams was in place long before Putrid set up shop, the courts rule that it has a legal property right to clean water drawn from the stream. In effect, Adams must agree to any pollution discharges by Putrid. The relevant data for this problem is the marginal damage cost (cleanup cost) ofAdams: MDC A = 2.222Qp, where Qp is tons ofpaper produced by Putrid. Putrid Paper is a perfectly competitive firm whose marginal cost (supply) of paper is MCp 20 + 10Qpo The market price ofpaper products is $240 ton. Recall from HW#2 that producer surplus = Total Revenue - :LMC, but here the functions are continuous and linear. • Compute the dollar amount ofinefficiency arising from the uncorrected pollution ofPutrid and show this on a diagram. Round to whole dollars and tons ofpaper. (10) • Because Adams has the right to clean water, bargaining starts at Qp == O. Determine the maximum willingness to pay and minimum compensation required by each party once they agree on a level of Qp. (10) • If Adams and Putrid trade at the optimal marginal damage cost per ton, compute the gains and losses to each and the social net benefit ofthis Coase solution to external costs. Hint: although the functions are linear, not all relevant areas are simple rectangles and triangles, but every area can be found by adding or subtracting rectangles and triangles. You can also integrate: f20 + 1OQp dQp = 20Qp + 1012 Qp 2, for example. You can check your answer by summing gains and losses which should sum to the net efficiency gain. (10) eWhat is the corrective tax required to induce the socially efficient output ofpaper? (3) 2. This question is about Pareto Efficiency. Adam and Eve have broken up, and now we have Randy and Eve who produce and consume figs (F) and apples (A). The production possibility frontier PPF is F2 + A2 = 100, which you will recognize as a circle with max F 10 and max A 10. Be careful to plotfigs F on the vertical axis and apples (A) on the horizont at axis or you will get messed up. The slope ofthe PPF is dF IdA = - AIF which exhibits the usual bowed-out shape and economically necessary slope properties: the curve gets steeper as you move down it. e At F == 8 and A = 6 what is the marginal rate oftransformation between figs and apples (MR T AF)? What does this MRT mean? Show this on a labeled diagram of the PPF, along with the corresponding Edgeworth Box inside the PPF. (10) eRandy and Eve each have four figs and three apples to start. Randy's 0 origin is the lower left and Eve's 0 origin is eRandy and Eve each have four figs and three apples to start....
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This note was uploaded on 12/05/2009 for the course ECON 4160 taught by Professor Vitaliano during the Fall '08 term at Rensselaer Polytechnic Institute.
- Fall '08