Econ381/ES312 Midterm

Transcription

1 Econ381/ES312 Midterm Instructions: Answer 10 of the following questions in you exam booklet. You have 50 minutes, and each question is worth 5 marks. 1. Can a model be useful when it is based on assumptions that are clearly false? Why or why not? Yes, a model can be useful even when based on assumptions that are false. The value of a model is its ability to predict. For example, we see that the price taking assumption of a perfectly competitive equilibrium was clearly false in our experiments (trades took place at a range of prices). Nevertheless, the competitive equilibrium did a good job of predicting the quantity, the average price, the consumer and producer surplus in our experiments: a useful model despite the validity of the assumptions made. 2. Demonstrate that a perfectly competitive equilibrium maximizes social welfare (in the absence of externalities). Choose any level of output other than the equilibrium quantity: for example either 2 or 4 in the following graph. At an output of 2 the marginal benefit of an additional unit of production exceeds the marginal cost of producing it, and if we expand output marginally welfare goes up: thus this level of output cannot be maximizing social welfare. At an output of 4 the marginal cost of production exceeds the marginal benefit of the good, and if we reduce output marginally welfare goes up: thus this level of output cannot be maximizing social welfare. The only time we cannot improve social welfare by marginally changing output is at the competitive equilibrium quantity, thus proving that the competitive equilibrium maximizes social welfare. 1

2 p supply demand q 3. Is economics (and environmental economics) anthropocentric? Is this a problem? Why or why not? Yes, economics (and environmental economics) are anthropocentric. Whether or not it is a problem is debatable. On the one hand, if there are aspects of the ecosystem that are not valued by humans (perhaps because we are too dumb to realized their importance), then these values will not be included in determining the socially optimal course of action: even our optimal choices will not actually be optimal. On the other hand, it is difficult enough to maximize the welfare of humans (who can at least answer questionnaires). It is hard to fathom how we could expand the scope to the welfare of all organisms. Perhaps our best hope is to convince people to value the ecosystem beyond their narrow self-interest. 4. Why do people pollute the environment? Would social welfare be maximized if we eliminated pollution? Describe two government interventions can reduce the amount of emissions. People pollute the environment when it is the cheapest way to solve their waste disposal problem. No, social welfare would be zero if we eliminated pollution. The only way for there to be no pollution is if there are no humans. Government can 1) tax emissions: for every unit of the emission, the emitter would have to pay a tax. 2) issue non-transferable permits (which is 2

3 equivalent to setting a standard): emitters are only allowed to emit the amount of pollution specified by the permit or 3) issue transferable permits: same as 2) but firms can trade permits, ensuring that the permits end up in the hands of the producers who value them the most. 5. Why do property rights matter regarding externalities? Provide an example comparing two goods, one where property rights are well defined and one where they are not. When property rights are well defined resources will be utilized efficiently. An example is cookies. When I was growing up my mom made the best cookies. When my dad was around there was a common pool resource aspect to a batch of cookies: we would both consume cookies at a faster than optimal rate, with the realization that if we did not, we would get a smaller share of the batch. Only once my mom split the batch into individual cookie jars did a batch of cookies last more than 24 hours. 6. What does sustainability mean? What sort of substitutability does sustainability require? Sustainability is the assumption that technology, labour and capital can be substituted for the natural capital that we are continually converting to waste. If we can make this substitution then future generations will not necessarily be worse off than our current generation. 7. Would it ever be optimal to completely ban a market (or, alternatively set a tax so high there are no trades) where there is a negative externality? Why or why not? If yes, under what conditions? This is debatable. If marginal damages at zero emissions are higher than the marginal abatement cost at zero emissions, then yes, it would be optimal to ban this market (or tax it heavily enough to ensure zero emissions.) But it is hard to fathom a pollutant that would meet this criteria. Maybe pcb, asbestos, cfc? 8. When does it make sense to graph pollution damages in terms of the quantity of the output vs. the quantity of emissions? Which approach is more general? If the only way to reduce emission is to reduce the quantity of the good being produced, then it makes sense to graph pollution damages in terms of the quantity of the good being produced. However, firms typically have other ways to reduce emissions other than just cutting back the amount of the good that they produce: they can recycle the emissions, switch to cleaner inputs, improve their technology, install smokestack scrubbers, 3

4 etc. When the firm has several ways to reduce emissions it makes more sense to plot pollution damages in terms of the emissions. Because the firm has more ways to reduce emissions, this approach is more general. 9. What determines the steepness of the marginal damages function? How noxious the pollutant is, the presence or absence of victims, and the environment s assimilative capacity. 10. What are some ways a firm can abate emissions? In a perfectly competitive market, what ensures that the marginal abatement cost is zero for the first unit of abatement? Firms can 1) reduce the quantity of output they produce, 2) recycle emissions, 3) switch inputs, 4) improve technology (less waste per unit produced), 5) media shift (smokestack scrubbers take airborne/gaseous pollution and render it a liquid or solid). In a perfectly competitive market the last unit of the good sold generates zero surplus to society. Thus the opportunity cost of marginally reducing output (in a perfectly competitive market) is zero. 11. Show via an example that the equimarginal principle must hold in order for abatement costs to be minimized. Suppose that the marginal abatement cost was not the same across multiple sources of a pollutant: for example suppose that the marginal abatement cost at firm 1 is $3 and at firm 2 it is $2. The same target level of abatement could be reached, with lower cost, if firm 2 abated one more unit (-$2) and firm 1 abated 1 less unit (+$3). The only time this type of cost savings is not available is when the marginal abatement costs are equalized across all sources 12. Depict graphically the socially efficient level of emissions. (graph in emissions vs. $ space) Prove that it is the socially efficient level of emissions. Choose any level of emissions other than the e : for example either 2 or 4 in the following graph. At an emissions level of 2 the marginal abatement cost is larger than the marginal damages and if we marginally increased emissions social welfare goes up: thus this level of emissions cannot be maximizing social welfare. At an emissions level of 4 marginal damages exceed the marginal abatement cost and if we marginally decreased emissions social welfare goes up: thus this level of emissions cannot be maximizing social welfare. The only time we cannot improve social welfare by marginally changing emissions is when emissions equal e thus proving that e maximizes social welfare. 4

5 $ e** MD MAC emissions 5