Solution 3 - ECON/FRE 374 Problem Set 3 Instructions: a)...

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1 ECON/FRE 374 – Problem Set 3 Instructions: a) Your grade on this problem set will be determined by randomly grading a single problem from the set below. It is thus important to do each question carefully as any one problem could determine your grade. b) Problem sets are to be handed in at the beginning of class. Please do not upload your problem sets in webct. c) Any problem set received after the time it is due will not be graded. d) Please label and mark all graphs clearly. Questions (each question is potentially worth 10 points): Question 1 Suppose local governments in Brazil harvest heavily the Amazon forest. Their marginal net benefit is represented by MB = 900 - X, where is the number of harvested acres of forest. The world’s community is affected by this over-harvesting and has a marginal damage of MD = ½ X. (Using graphs would certainly help answering the questions.) In the absence of possible bargaining, a. what is the number of harvested acres? 900 The local governments harvest until the marginal net benefit of the last acre harvested is 0. Then, 0 = 900 – X. b. what are the total net benefits to local governments? 405 000 The total benefits are the triangle area under the MB line. Then, (900*900)/2 = 405 000. Suppose it is possible to bargain and there is no enforceability problem. The United Nations offer a compensation to local governments for them to limit the harvested acres to the point where social surplus is maximised. c. what is the minimal amount the local governments are willing to accept? 45 000 The optimal amount of harvested acres is where MB = MD (the damage here is the cost). Then, 900 – X = ½ X which leads to X = 600. By reducing the harvested acres from 900 to 600, local governments lose net benefits. The amount lost is 300*(900-300)/2 = 45 000. Hence, to accept the compensation, they have to get at least 45 000. d. what is the maximal amount the UN are willing to offer? 112 500 The total damages at 900 are 202 500 ( = 900*450/2 ). The total damages at 600 are 90 000 ( = 600*300/2 ).
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2 By the reduction, the world’s community is avoiding damages of 112 500 ( = 202 500 – 90
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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 University (Engineering School).

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Solution 3 - ECON/FRE 374 Problem Set 3 Instructions: a)...

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