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# Econ 374 Practice Midterm Answers - Solutions to the...

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Solutions to the practice mid-term NOTE: Consider these solutions as a tool to help you practice your questions. They are not complete. For instance, in some cases graphs are not presented in the solutions. Students must draw graphs if they are instructed to do so in the exam. In some cases, the solutions might not have complete definitions or may omit the discussion requested in the question. Use your judgement while answering questions in the exam. 1) a) External Benefits (EB) are benefits that accrue to people not party to the decisions that give rise to the benefits. Static market price and output is at p m and q m respectively. The socially efficient price and output is at p* and q* respectively. Note the assumption of no external costs, in other words, the supply curve and marginal social benefit coincide (see graph below) b) Social inter-temporal efficiency in the use of natural resource refers to an outcome that maximizes society’s net benefits across all effected periods from use of the natural resource today. In other words an inter-temporal outcome accounts for the future consequences of today’s decision. The condition to achieve an inter-temporally efficient outcome is MCB=MCC+UC, where MCB= Marginal Current Benefits from use of the resource today, MCC=Marginal Current Costs from use of the resource today, and UC is User Costs, which is the change in discounted value of future net benefits. 10 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 Quantity of Output Costs and Benefits D MSB=D+EB S=MSC p* p m q m q*

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c) Coase Theorem: Define property rights and allow bargaining among interested parties and achieve the social outcome: The two conditions required for the Coase theorem are : Property rights must be well defined, enforceable, and transferable. There must be a reasonably efficient and competitive system for interested parties to come together and negotiate. If these conditions are hold then regardless of the who holds the initial property rights society can achieve an efficient outcome even in the presence of externalities. d) Open access resources are a class of resources whose market use leads to the complete dissipation of resource rents. The usual reason for this dissipation is that if people use the resource they impose externalities on other users, and as there are no restrictions on use (thus “open access’) new entrants always enter to use the resource as long as their marginal gain is higher than their cost. In class these resources were defined as “a class of natural resources whose use gives rise to external costs, and proper management involves public goods and external benefits”. As their use gives rise to external costs they are overused under a market system of usage. As their management provides external benefits, levels of management of such resources are underprovided. Overuse and under-management relative to the social optimal lead to over-exploitation of such resources.
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Econ 374 Practice Midterm Answers - Solutions to the...

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