Practice Questions for Midterm Solution

# Practice Questions for Midterm Solution - ECON/FRE 374...

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1 ECON/FRE 374 – Practice Questions Questions (each question is potentially worth 10 points): 1) Consider a three-period model of nonrenewable resource extraction. Lay out the maximization problem in a way analogous to the two-period model in the lecture notes, and determine the explicit expression for user cost. For a three period model we wish to maximize, PVNB = (Net benefits in year ) + (Net benefits in year 1) * (1/1+r) +(Net benefits in year 2)*(1/1+r) 2 The optimal first year’s extraction is, P(0) – MC(0) = [(P(1) – MC(1)) / (1+r)] + [(P(2) – MC(2)) / (1+r) 2 ] In terms of user cost, UC= [(P(1) – MC(1)) / (1+r)] + [(P(2) – MC(2)) / (1+r) 2 ] Thus the optimal expression is P(0) = MC(0) + [(P(1) – MC(1)) / (1+r)] + [(P(2) – MC(2)) / (1+r) 2 ] 2) Consider the extraction of a known stock problem for nonrenewable resource. Assume the existence of only two periods: t 0 and t 1 . Let the (inverse) demand functions of the two periods be: p 0 = 15 – q 0 and p 1 = 15 – q 1 . Let the marginal extraction costs be MC 0 = 5 + q 0 and MC 1 = 5 + q 1 . And let the rate of discount r = 0.05.

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## This note was uploaded on 11/29/2010 for the course ECONOMICS 300-400 taught by Professor Varies during the Spring '10 term at Cornell.

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Practice Questions for Midterm Solution - ECON/FRE 374...

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