Econ%20131-Midterm-Answers

Econ%20131-Midterm-Answers - Economics 131 Question 1...

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Unformatted text preview: Economics 131 Question 1 Midterm Answer Key November 3, 2009 (a) 20-Q=2 Qm=18 Pm=$2 Q*=16 P*=$4 Q*<Qm due to the negative externality. (b) (i) Tax , (ii) t*=$2 per unit of textile (c) (i) Subsidy, for reduction up to (Qm-Q*), (ii) s*=$2 per unit of textile, total subsidy for $2x2=$4 (d) Need to correctly draw and label graph. Consumers have positive surplus under the tax policy but have negative surplus under the subsidy, polluter gets surplus equal to the total subsidy and no surplus under the tax. Tax Subsidy Taxpayer/Society Revenues(+)/Payments (-) Tax collected from polluter Subsidy paid to polluter +t*Q*=$2x16=$32 -s*(Qm-Q*)=-$2x2=-$4 Net Benefits Consumer Surplus-Cost of Gain from Pollution Reduction pollution CS lost CS(Q*,P*)-MCxQ* MCx(Qm-Q*)-CS(Qm- =0.5x$16x16-$2x16=$128-$32 Q*,Pm)=$2x2-0.5x$2x2=$2 Q* Surplus $128 -$2 Polluter Revenues(+)/Payments (-) Tax paid to taxpayer/society Subsidy received from society -t*Q*=-$32 + s*(Qm-Q*)=$4 Net Benefits +(Pm-P*)Q*=$2x16=$32 Zero costs as the polluter breaks even at any quantity 0 Surplus Question #2 (a) 0 $4 This rationing policy would not result in an efficient allocation. The MWTP for the last unit consumed by the agricultural consumers ($10) is not equal to the MWTP for the last unit consumed by the residential consumers ($9). Therefore, a Pareto improving trade exists in which the residential consumers transfer some of their water to the agricultural sector. (b) The uniform price will result in an efficient allocation. Both agricultural and residential consumers will purchase water up until their MWTP for the last unit of water is equal to $9.75. Therefore, the agricultural consumer's MWTP for an additional unit of water will equal the residential consumer's MWTP. All 90 HCF will be consumed and there are no Pareto improving trades available. c) With the efficient price increase, the county will earn an additional $3.75 on each of the 90 HCF consumed ($337.50 additional revenue). Whether the agricultural and residential consumers prefer the rationing policy or the price policy depends on how the county uses the additional revenue. If the county returns at least $269.9375 (CS from the rationing policy minus CS from the price policy for the agricultural consumers) to the agricultural consumers, they will prefer the price increase over the rationing policy. If the country returns at least $67.3125 (CS from the rationing policy minus CS from the price policy for residential consumers) to the residential consumers, they will prefer the price increase over the rationing policy. Since , the government earns enough additional revenue to compensate both the agricultural and the residential consumers in order to ensure both groups prefer the efficient price policy over the rationing policy. Question #3 a) Demand: b) i) Find the price of visits for the average person using the marginal benefit curve: Area under demand curve: Calculating discrete trips: Either method/answer is acceptable in this case. ii) Area under demand curve: Calculating discrete trips: iii) Using area under demand curve: Using discrete trips: c) i) The Total Cost is $6 million ($1 million for maintenance and $5 million in lost logging profits, or opportunity cost). If the Forest Service only uses hiking benefits of $4.8 million (or $3.6 million), then: Total Benefts Total Costs = -$1.2 million (or -$2.4 million). The forest service should not set aside the land. ii) So far the Forest Service has only included the direct use-value of timber extraction to the indirect/non-consumptive use-value from tourism. For a complete cost benefit analysis, the Forest Service should include all sources value, including non-use values like existence value for forest preservation, biodiversity and habitat, indirect use-value for carbon sequestration and prevention of soil erosion, etc. If these non-use and indirect use-values are large enough, the Total Benefits may exceed the $6 million on Total Costs, and the Forest Service may want to set the land aside. iii) No, the Forest Service should not charge a fee. Raising the price of a trip will ration out the marginal trips so that hikers will take fewer trips and receive fewer benefits from park, reducing consumer surplus by more than the revenue gained from the fee. The fee would raise the price of a trip to $65 for an average user. At $65, the average demand for trips per hiker is 10-6.5 = 3.5 trips. Consumer Surplus becomes The loss in consumer surplus is 4.8million-3.7million=$1.1 million The revenue from the fee is $5*3.5trips*60,000people=$1.05 million. Total Benefits Total Costs = $3.75 million $5million = -$1.25 million<-$1.2 million It is also acceptable in this problem to treat trips as discrete units. The $65 trip cost would reduce individual trip demand to 3 trips. Consumer surplus becomes $25+15+5=$45. Total consumer surplus would be 45*60,000=$2.7million<$3.6million. The loss in consumer surplus is $900,000. The revenue from the fee would be $5*3trips*60,000people = $900,000. Total Benefits Total Costs = $2.7million $5.1million = -$2.4 million. Using this method, the Forest Service has not created any value by charging the fee. Because we are using an average demand curve over all hikers, using the demand curve method is preferable to the discrete trips approach, but either will receive full credit. iv) Charging the fee reduces the Total Benefits from preservation, so it would not change the decision if the Forest Service had already decided against it as in part (i). If all sources of non-use and other indirect use-values had been included and were large enough to justify preservation, imposing the fee could tip the balance towards not preserving the land unless these other values are large enough to cover the losses created by the fee. Question 4 (a) NB(a)=$500,000>0, adopt new technology (b) NB(b)=$700,000>NB(a), adopt b (c) (i) E*=4.5million (ii) 0.5 million=(5-4.5)million (iii) 0.5*0.5million*$10=$2.5million, (iv) $10*0.5million=$5million, (v) subsidy, s*=$10. (d) Adopt c, as the benefits $2.5 million net benefits per year, which is greater than a and b. NOTE: Part (d) was unintentionally much easier than originally planned since the question had a typo. The marginal benefit curve should have been: MB(E) = 100 0.002E Instead of MB(E) = 100 0.00002E With the intended MB curve, the net benefits would only be $25,000 per year instead of $2.5 million and then you would need to consider how the size of the discount factor would affect the choice of the best alternative. With no discounting, (i.e. a discount factor of 1 or a discount rate of 0), in 20 years, option c) would yield $500,000 of net benefits, which would make it just as good as option (a), but not as good as option (b). With any positive discount rate or discount factor lower than 1, both (a) and (b) would yield greater net benefits. ...
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This note was uploaded on 12/09/2009 for the course ECON 131 taught by Professor Groves during the Fall '09 term at UCSD.

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