If the fee was mass-based or weight-based, people would try to reduce the mass of what they threw away, but wouldn t worry about compacting.

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1 ECON 311: Economics of the Environment Name: Spring 2008 Bellas Midterm 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. We talked about pay as you throw programs in which people pay an amount for trash disposal based on how much they throw away. These sorts of programs might be implemented in many different ways, with different implications for people s behavior. Discuss briefly how people would respond to a fee per volume of trash thrown away and how this would differ from their response to a fee per pound of trash thrown away. (3) People facing a volume-based fee will do their best to compact their trash, preferably at the sub-atomic level, although this might generate other externalities. If the fee was mass-based or weight-based, people would try to reduce the mass of what they threw away, but wouldn t worry about compacting. 2. A Twin Cities suburb is hoping to expand its network of bicycle paths. The total cost of this expansion would be $5M. The benefits of this expansion, in terms of reduced traffic congestion and air pollution and exercise related health benefits will be $4M. However, there is federal money available that would cover half of the cost of the expansion. Explain how the issue of standing enters into the decision as to whether or not to expand the network of bicycle paths, assuming the figures given in this question are correct. (3) If standing is given only to local people, the net benefits will be $4M-$2.5M=+$1.5M, so the project is desirable. If, however, standing is national, the full costs are considered and net benefits are negative, so the project is not really desirable. Page 1 of 10

2 3. Consider the following diagram showing the marginal value (MC) and the marginal cost (MC) for hot water. A. On the graph above, indicate the efficient quantity of hot water this person will face if they face a price of P, which is equal to the marginal cost. Label this q*.(2) B. On the graph above, indicate the quantity of hot water this person would use if they split the cost with another person (label this q B ) and show the dead weight loss associated with using this quantity. (3) If you split the cost, your cost of using an additional unit is half of what it was originally. C. Explain why the quantity indicated in part B is inefficient. (2) The quantity in part B is inefficient because the MV for those extra units is less than the marginal cost of providing them. Page 2 of 10

3 4. Explain why the issue of standing is important in determining the efficient level of provision of a public good. (3) The more people who have standing the greater the total marginal value and the larger the optimal level of provision will be. 5. One problem with wind power (generating electricity with wind-driven turbines) is that large numbers of migratory birds can be killed when they fly into the blades of these windmills. A program that found ways to reduce the number of birds killed would generate environmental benefits. Of the methods discussed in class, which do you think would be most appropriate for valuing the birds saved by developing safer wind turbines? Explain your answer.(3) This would probably have to be contingent valuation, a method in which a survey is conducted asking people about willingness to pay to prevent the birds deaths at some cost via a credible program. This is necessary because there probably isn t any market for the birds or in which the birds play a key role, so their value really depends on peoples non-use values of the birds. The only way to get at these values is through contingent valuation. Page 3 of 10

4 6. Imagine that there are three people living on a lake and that cleanliness of the lake is a public good that they share benefits from. The marginal cost of improved cleanliness and the marginal value (or marginal willingness to pay) of each person for improved cleanliness are as described in the following table: Levels of Improvement MC MV A MV B MV C MV T MV A+B 1 $ 5 $15 $13 $ 9 $37 $28 2 $10 $12 $11 $ 8 $31 $23 3 $15 $ 9 $ 9 $ 7 $25 $18 4 $20 $ 6 $ 7 $ 6 $19 $13 5 $25 $ 3 $ 5 $ 5 6 $30 $ 0 $ 3 $ 4 A. What is the optimal number of levels of improvement? (2) 3, this is the last level for which the total marginal value is still greater than the marginal cost. B. Explain why one additional level of improvement would not be efficient. (2) If there was one more level, the marginal cost of that additional level would be greater than the total value attached to it. C. How does your answer to part A change if person C doesn t have standing? (2) It doesn t change. This is a bit odd as the optimal level of provision of a public good usually falls as the number of people with standing falls. Page 4 of 10

5 7. Consider a standard supply and demand diagram for some good such as sandwiches. In your answers below, show and label all relevant curves and the dead weight loss. A. Diagram a negative externality that results from the production of sandwiches. (2) B. Why might there be a negative externality associated with consumption of sandwiches? (2) The sandwiches might give you bad breath or gas, might leave bits of food in yoru teeth (which other people have to look at) or might leave you lethargic and unproductive at work in the afternoon. Page 5 of 10

6 8. Imagine that an environmental regulation will reduce the supply of a particular good, reducing gains from trade in that market. Further, imagine that demand for this good might be relatively elastic (meaning that the demand curve is fairly flat) or relatively inelastic (meaning that the demand curve is fairly steep). A. If demand is relatively inelastic, who will bear most of the burden of the supply reduction in the market, consumers or producers? Explain or show this. (2) If demand is inelastic or steep then a supply reduction will be reflected primarily in a price increase. Because the price will increase a lot, we can say that the burden of this supply reduction will be borne primarily by consumers. B. Under which condition, elastic demand or inelastic demand, will the environmental regulation be more likely to be defeated in a representative democracy? Explain your answer. (2) The environmental regulations will reduce supply. If demand is elastic, the burden of this reduction in demand will be borne by suppliers, who are likely to be a smaller but better organized group than consumers. As a result, we would say that in a representative democracy, the policy will more likely be defeated if demand is elastic. Page 6 of 10

7 9. Three factories are each emitting eight tons of a particular air pollutant. The state s pollution authority would like to cut the total emissions by nine tons. The factories have the following marginal cost of abatement schedules: Tons Abated MC A MC B MC C 1 $1 $8 $3 2 $4 $11 $7 3 $7 $14 $11 4 $10 $17 $15 5 $13 $20 $19 6 $16 $23 $23 7 $19 $26 $27 8 $22 $29 $31 A. One way to reduce emissions by nine tons would be to have each factory reduce emissions by three tons. What would be the total cost of this? (2) =66 B. What emission fee would result in a reduction in emissions of nine tons? (2) Anything between $11 and $13. C. For this part, forget about the goal of a nine ton reduction. Imagine that ten tons of emissions permits will be sold at auction. How many permits will each firm purchase? (2) A buys 2 B buys 4 C buys 4 Page 7 of 10

8 10. Consider the following diagram showing the relationship between the level of cleanliness of a lake and the total value of that lake. A. Draw in the associated marginal value curve on the lower set of axes. Please be careful and clear in your diagram. (2) B. Draw in a marginal cost curve in the lower diagram and indicate the efficient level of cleanliness based on the marginal cost and marginal value curves you have drawn. (2) This answer depends on the marginal cost curve that you draw in. Page 8 of 10

9 11. Now consider a diagram of the level of cleanliness of a lake. For the indicated marginal cost (MC) and marginal benefit (MB) curves, please answer the following. A. Of the levels of cleanliness indicated on the graph (A, B, C, D and E) which might be optimal and which would never be optimal? (2) A or C might be optmal. B, D and E would never be optimal. B. How would you choose between two or more points that might be optimal? (2) This would depend on the area between the curves between points A and B and the areas between the curves between points B and C. If the area between the curves between A and B is larger, then point A is optimal. If the area between the curves between B and C is larger, then point C is optimal. Page 9 of 10

10 12. Imagine that you are trying to value a particular piece of wilderness that people use for recreational hiking and cycling. While this area has no entrance fee, statistics have been kept on who visits and how frequently they visit the area. Visitors come from two cities. City A is 20 miles away and has 5,000 residents. They make an average of 6 visits per year. City B is 60 miles away and has 40,000 residents. They make an average of 2 visits per year. The cost of traveling is $0.40 per mile. Using the travel cost method, estimate the annual active use value of this area to the people living in these cities. (3) Remember that these are one way distances, but the value of the wilderness needs to be based on round trip travel cost, so the cost for City A is $0.40*40=$16.00 and for City B is $0.40*120=$ The graph of the demand curve is as follows. The areas of the CS are 0.5 * 2 * ($64-$48) = $ * 6 * ($64-$16) = $144 And the total value is (40,000 * $16) + (5,000 * $144) = $640,000 + $720,000 = $1,360,000 Page 10 of 10