PS7 - Econ 131 Problem Set#7 Question 1 In the Island of...

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Unformatted text preview: Econ 131 Problem Set #7 Question 1 In the Island of Trevia, the textile industry dumps pollutants into the river. (a) The Ministries of the Economy and the Environment conducted a study to estimate the MB and MC of water pollution. You are an advisor to both ministries and are asked to help them use the studies to determine the optimal level of pollution. (b) Now that the optimal level of pollution is determined, both ministers ask you to recommend a policy to achieve the optimal level of pollution. (i) Which policy (or policies) would achieve the optimal level of pollution in the least costly way if all firms in the textile industry are identical? (ii) If you mentioned more than one policy in (i), would you recommend a specific one in terms of dynamic efficiency? (iii) How would your answer change in (i) and (ii) if all firms in the textile industry were not identical? (iv) How would your answer change in (i) and (ii) if you know that the estimated MB and MC curves may be measured with a lot of error? Question 2 If a country has two sources of energy, one is depletable, A, and the other is renewable, B. (a) If the country is only using resource A, when is it going to switch to resource B? (b) Assume the marginal cost of extracting of resource A is constant, is the country going to switch before or after resource A is depleted? (c) Now assume that the marginal cost of extraction of resource A increases linearly, how is the switch point in this case compare to the switch point in part (b)? (d) Now assume that the marginal cost of extraction tends to infinity the reserves of resource A tend toward depletion, is the switch point from resource A to resource B going to be before the depletion of resource A or after? Question 3 Hotelling's model of resource extraction predicts that the real price per unit of a non-renewable resource in a competitive industry will change over time according to the following equation: . If we look at the real price of crude oil over the past 40 years, the price has not increased as the Hotelling model predicts. Instead, the price has moved around an average of $35/barrel (2008 dollars). Over the same time, technological improvements have reduced the cost of extracting oil from the ground. Could advances in extraction technology have prevented the price of oil from steadily increasing over the past 40 years? (Hint: how would extraction technology advances impact the MC in the above equation?) Question 4 According to an IEA official, "One day we will run out of oil. It will not be today or tomorrow, but one day we will run out of oil." What is wrong with this statement? (Hint: what will happen to the price and quantity demanded of oil as it becomes scarcer?) Question 5 Fossil fuels (coal, natural gas, oil) are the most common sources of energy. When these fuels are burned, harmful pollutants are emitted into the atmosphere. Chapter 14 of the text describes the following three broad methods for reducing the amount of pollution emitted: 1) change the economic incentives, 2) expand technological options, and 3) information programs. Describe each method and provide an example of a specific policy for each option. ...
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