1. What was your favorite thing that you learned or your favorite thing that we talked about in this class? (3)

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1 ECON 311: Economics of the Environment Name: Fall 2008 Bellas Final Exam You have three hours and twenty minutes to complete this exam. Answer all questions, explain your answers, label axes and curves on graphs and do your own work. Fifty points total, points per part indicated in parentheses. 1. What was your favorite thing that you learned or your favorite thing that we talked about in this class? (3) 2. In class, we discussed the environmental Kuznets curve. The environmental Kuznets curve is a U-shaped relationship between environmental quality and per capita GDP and suggests that very poor and very rich countries have good environmental quality while countries with intermediate levels of income per person have relatively poor environmental quality. Offer three criticisms of this idea. Put somewhat differently, what are three different problems with using the environmental Kuznets curve as a model of the relationship between per capita GDP and environmental quality? (3) The model assumes an industrial model of development. If economies can develop in another, more environmentally friendly way then there may not be the period of low environmental quality. The important determinant of environmental quality might not be just a country s per capita GDP, but its per capita GDP relative to that of its neighbors. There are some environmental measures that don t improve as an economy continues to develop, such as quantity of municipal solid waste and greenhouse gas emissions. Page 1 of 8

2 3. Use graphs with abatement on the horizontal axis to show the cost savings for a firm that adopts lower marginal cost abatement technology under the following policy regimes. A. Flexible or Changing Standards (3) B. Flexible or Changing Fees (3) Page 2 of 8

3 4. Imagine that a car battery costs $30 to manufacture and $30 to dispose of properly. This same battery, however, can be disposed of improperly in such a way that it cannot be traced back to its owner at a cost of $15. What is the range of subsidies that might be offered for proper disposal that would effectively encourage disposal without encouraging companies to produce batteries just to dispose of them and collect the fee? (3) The fee must be between the difference between the costs of legitimate and illegitimate disposal and the sum of the costs of manufacturing and legitimate disposal. Min fee is $30-$15 = $15 Max fee is $40 + $3- = $60. So, the fee must be between $15 and $ We discussed issues related to implementing environmental regulation at the state versus the federal level. Thinking specifically about issues related to air quality, what types of air emissions should be regulated at the state level and what types of air emissions should be regulated at the federal level? Explain briefly. (3) Air emissions that are deposited locally could be regulated locally. Air emissions that are likely to cross state boundaries should be regulated at the federal level. Page 3 of 8

4 6. We designed a fishing game in class. As part of this process, there were several aspects of the game about which we had to make decisions and, as you all considered these decisions, I was careful to query you about the impact that your decision would have on the likelihood that the fish would be hunted (fished) to extinction. For each of the following decisions, tell me which option is more likely to lead to the fish being hunted to extinction and explain why. If you offer no explanation, you will receive no credit. A. The number of firms fishing could be either two or four. (2) Four firms is more likely to lead to extinction because it is more difficult for four firms to agree to a limitation on fishing that it would be for two firms to agree to a limitation on fishing. B. The demand for fish could be either elastic or inelastic. (2) If the demand for fish is elastic this will more likely lead to extinction because the price of fish won t fall much as the quantity caught and sold increases, so there will be increased incentive for overfishing. C. The interest rate could be either zero or positive. (2) A positive interest rate will more likely lead to extinction because this means that the future is valued less than the present it, so there is less value to be had (in present value terms) by preserving the fish stock. Page 4 of 8

5 7. U.S. legislation requires that landfills that accept toxic waste carry insurance against damages that would be caused if that waste leaks out of the landfill. The result is that a large insurance company is essentially on the hook for any damage resulting from the landfill. A. Explain how this leads to very close monitoring of operations at the landfill. (3) The insurance company that is exposed to a great amount of liability will hire people to monitor operations at the landfill and to ensure that the landfill operators are being careful. B. How does the level of monitoring and the resulting level of caution at the landfill change if the insurance company, in the interest of risk management, shares its landfill risk exposure with many other large insurance companies? Explain why. (3) If no one company faces large exposure to losses associated with damages from the landfill then no one company will have any great incentive to hire monitors to watch operations at the landfill. Page 5 of 8

6 8. Use the greater than (>), less than (<), equal to (=) or uncertain (???) symbols to characterize the relative incentives offered by the different policy regimes for firms to adopt lower cost abatement technologies. Two points each. For example, if you believe that flexible standards offer greater incentives than do flexible subsidies, you would do the following: Flexible Standards > Flexible Subsidies A. Flexible Fees > Fixed Fees B. Flexible Standard < Fixed Standard C. Fixed Fee = Fixed Subsidy D. Flexible Subsidy < Fixed Subsidy Page 6 of 8

7 9. You may remember this question from the midterm. Imagine that an environmental protection agency uses emission fees to control pollution in its area. Should the money that emitters pay in emission fees be included as a cost of the pollution control program or as a benefit of the pollution control program? Explain your answer. (3) This is a matter of standing. If standing is universal, then the payments should be neither a cost nor a benefit, they should be counted as a transfer. 10. Imagine that a rancher who raises steers and a farmer who grows crops operate right next to each other. The problem is that the steers do some damage to the farmers crops, as described in the table below. # of steers Marginal private cost Marginal crop damage 1 $100 $25 $125 2 $200 $50 $220 3 $300 $75 $375 4 $400 $100 $500 5 $500 $125 $625 Imagine that the price of steers is $510. Marginal Social Cost A. What is the socially optimal or efficient number of steers for the rancher to raise? (3) Four steers. This is the number at which the marginal social cost is less than the price. B. Assume that rancher has the right to raise as many steers as she wants and bears no liability for damage done to the farmer s crops. How can Coasian bargaining lead to the socially optimal outcome? (3) The rancher will want to raise five steers. The farmer would offer a payment of between $10 and $125 for the rancher to cut back from five to four steers. Page 7 of 8

8 11. Explain what the equimarginal principle is and how it assures that the cost of abatement (or even the cost of production) will be minimized in a situation where there are multiple sources of emissions (or output). (3) The equimarginal principle is the idea that costs of production or abatement from multiple sources are minimized when the marginal cost of production or abatement is equalized across sources. Equality of marginal costs assures cost minimization because if marginal costs are not equated, costs could always be lowered by shifting production or abatement from a source with higher marginal cost to a source with lower marginal cost. Page 8 of 8