Environmental and Resource Economics, Agec 350, Fall 2011 Midterm Exam Answer Key

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1 Environmental and Resource Economics, Agec 350, Fall 2011 Midterm Exam Answer Key 1. (9 points) In the Burton and Carters Creek watershed there are point sources such as waste water treatment facilities that are using state-of the art pollution practices to reduce their pollution, and nonpoint sources like pastures where pollution literally flows off the property into the creek. Explain why this situation is almost certainly an economically inefficient allocation of the responsibility to reduce pollution in the watershed. Clear that the student is referring to economic efficiency /3 Clear that the student understands that efficiency requires cost effectiveness /3 Some mention of marginal cost differing across sources /3 Economic efficiency requires cost effectiveness. That is, no matter what the environmental goal is, we want to achieve it at the lowest possible cost. The situation described clearly indicates that the marginal cost of reducing pollution from pastures where pollution literally flows off the property into the creek would be less than at the plants using state-of the art pollution practices. If the MCs are not equal, we can t be at a cost effective allocation. 2. ( points) Your Uncle Bob is a true believer in the free market. He s convinced that every environmental regulation needs to be eliminated. Write a short message to your uncle explaining why some level of government regulation of pollution makes sense in terms of social efficiency. Is it clear that social net benefits are considered? /4 Are marginal concepts used correctly to explain that for at least some /6 problems, the marginal benefit at zero is greater than the marginal cost? Partial credit if maximization of net benefits is stated. Dear Uncle Bob, I understand that you hate regulations, but if there were no environmental regulations then businesses would have no incentive to address pollution problems since the harm caused by pollution does not affect those businesses bottom line. Indeed, their fiduciary responsibility to their shareholders would prohibit them from doing so. So we d end up with a situation where the firms would continue a lot, even avoiding measures that would only cost a little to reduce their pollution. What this means in economic jargon is that their marginal to reduce pollution would be very low. On the other hand, when pollution is high, people suffer real harm: asthma, cancer, all sorts of ills. At such high levels, society is willing to make sacrifices to reduce pollution. So we re at a situation when the cost to reduce pollution is very low and the benefit to doing so is high to not do something means we re giving up opportunities to increase the net benefits to society as a whole. So please Uncle Bob, give up your extreme stance.

2 Last 4 digits of your UIN #: 2 3. (15 points) Consider the set of amenities (and disamenities) of the Texas A&M campus. a. What is one amenity with non-use value and who receives that value? Is the amenity a plausible environmental and natural resource amenity? /2 Taking into account the group identified, does the amenity have non-use /2 value, not non-extractive use The century tree is valued by all Aggies, even those who will never return to campus they value its pure existence. b. Succinctly describe how a contingent valuation study would be used to place a dollar value on the amenity in part a. Is a survey indicated /2 Is it clear that the student understands that a CVM study involves explicit /2 asking about an individual s WTP? We could conduct a survey through the Association of Former Students asking whether Aggies would be willing to pay for to protect the Century Tree. This would give the data that could then be used to estimate the WTP. c. What is one amenity that might be valued using the hedonic property method approach? Is the amenity one that could be plausibly valued using property values /3 Kyle Field d. Succinctly describe the data you would use and how it would be analyzed to place a dollar value on that amenity mentioned in part 0. Is it clear that property values will be used /2 Is it clear that differential property values will be used /2 Property values of homes and other properties could be collected. These data could then be used to tease out the effect that Kyle Field has on different types of properties around the city and, from that, estimate the dollar value of Kyle Field for the residents of the city. 4. RAT Repeat: (5 points) The figure below is essentially a reproduction of Figure 2.5 in the text. As there, assume that the units measures the number of miles of river that are protected. Using the letters on the figure, what would be the net benefits of a project that protects 6 miles of the river? Would it pass a benefit-cost test? $/unit 8 6 L M R V Y MC 4 N U K 2 X D=WTP 0 O S T W P Q (units) Should indicate positive net benefits of LRK and negative net benefits of /3 RVU. Since the positive triangle is larger than the negative triangle, it passes the /2 test LRK minus RVU. Since LRK is bigger than RVU, it passes the benefit cost test.

3 Last 4 digits of your UIN #: 3 $/Q MWTP per person MWTP (public good) 3 people Q.. 5. (20 points) The figure above presents the marginal willingness to pay curve for a good for a single person. There are 3 people in the world that demand the good and all have exactly the same MWTP curve. The marginal cost to produce this good is fixed at $3 per unit. (Correct numerical answers get full credit. For partial credit you will need to explain your answers) a. Assume that all the characteristics of efficient property rights are satisfied. What would be the socially efficient quantity of the good? 7 units/person (3 points) = 21 /5 b. Suppose that the good is non-rival and non-excludable. What would be the socially efficient quantity of the good? 9 (where Σ MWTP = MC) /5 Partial credit for evidence that there is an understanding of vertical aggregation of the MWTP curves. The public good MWTP curve is presented in the figure above. Where MWTP S =MC is the social optimum, at 9. c. Suppose that the good is non-rival and non-excludable. Person 1 acts independently to maximize her net benefits. How much of the good would Person 1 willingly purchase? If, after Person 1 has acted, Persons 2 seeks to maximize his net benefits, how much would Person 2 pay for? Person 1 would purchase 7 2/ Persons 2 and 3 would free ride, purchasing zero 3/

4 Last 4 digits of your UIN #: 4 d. Now suppose the direct benefits of the good are rival and excludable (as in part a), but for each unit produced the community is harmed. The value of this negative impact is worth $2 per unit. What would be the equilibrium quantity in the market? What would be the socially efficient quantity? Full credit if equilibrium is the same as in part a, or 21 /2 Efficient quantity would be 5 per person (2 points), 15 total /3 There is now an negative externality. Since it s an uncorrected externality it doesn t affect the equilibrium, but the socially efficient quantity would be where the MB = MC S, at 5 per person or 15 total. 6. RAT Repeat (5 points) Which of the following is a correct statement about Ronald Coase. He argued that the private allocation of public goods would be inefficient, thereby justifying government provision of things like parks and defense. He argued that through negotiation it is possible to efficiently address an externality and, as long as transaction costs are negligible, the efficient outcome will result no matter which party has the initial right. He showed that externalities can efficiently be addressed through the use of a tax. He demonstrated that either subsidies or taxes can be used to achieve an efficient outcome. all of the above 7. (15 points) The figure below presents the TOTAL costs that two firms would have to pay in order to reduce their discharges of pollution into a lake that the two share. Firm #1 Firm # $ (total cost) 15 5 TC 15 TC Pollution Abatement Pollution Abatement a. What is the marginal cost of abatement to each firm of their 4 th unit of abatement? TC = 4 for firm #1 and 7 for firm #2 /5 The MCs are indicated with the dots, the change in the TC for each additional unit. b. Suppose that government introduces a policy that pays each firm a subsidy of $4.50 per unit that they abate. Assuming that they have to choose to abate in whole unit increments, how many units would each firm abate? Correct uses the MCs: 4 for firm 1 and 2 for firm 2 /4 ½ credit if TC curves were used, 2 for firm 1 and 1 for firm 2 Abate as long as the MC is less than the subsidy. 0

5 Last 4 digits of your UIN #: 5 c. Suppose that each firm is initially required to abate 3 units. Could they make a deal that would keep the total pollution level unchanged but would make both firms better off? Explain why or why not? If they can make a deal, explain who would pay whom. Yes /2 Should mention that the MC to the firms are not equal at 3 & 3 so there are /2 possible gains from trade. Explain that firm 2 would pay firm 1, firm 2 abating less and firm 1 abating /2 more MC at 3&3. If 2 reduces its abatement by 1 unit it saves $5. If 1 increases its abatement by 1 unit (to 4) it s additional cost is $4. So a deal could be made. Clippings Questions For these questions you must provide a strong argument: 1) Define economic terms used, 2) use them correctly in the context of the article, and 3) use evidence from the article to back up your argument. 8. (11 points) In the situation described in the article, which of the three characteristics of efficient property rights is most clearly not satisfied? Give a brief definition of this characteristic and explain how it is not satisfied in this case. Either enforceability or exclusivity could be used /3 Argument gives a correct definition of the property /2 Argument applies that definition to the context of the article /3 Some evidence from the article is used /3 Enforceability was the easiest one. It means that the participants have a secure right to their property. Mitschke s rights are clearly not secure since the bird s eating his vegetables. Exclusivity is also not satisfied since Mitschke s management of his pest problem (via a shot gun) had negative external consequences on his bird-loving neighbors. Note that a bird cannot be an externality on its own. The definition of an externality is when one person s actions have impacts on others that are not reflected in market transactions. 9. ( points) Do you believe that an efficient outcome has been achieved? Explain why or why not. An appropriate description of an inefficiency or explanation of why an /4 efficient outcome has been reached is given. Efficiency or inefficiency is defined and used appropriately /4 Some evidence from the article is used /2 Good arguments could be made either way. You could say that because of the fine, we now have protected birds from Mitschke s gun, creating a public benefit valuable to his neighbors and bird lovers across the state (a public good) at relatively low cost. This appears to pass the benefit costs test. Or could argue that this has essentially tied Mitschke s hands, leaving him no option but to shut down his production. A more efficient outcome could have been achieved if a program were set up to compensate Mitschke for damage done to his crops (the public would pay the costs of the public good) or Mitschke could arrange with his neighbors (as representatives of the public) to compensate them any time he kills a bird, perhaps through a donation to the Audubon Society.

6 Last 4 digits of your UIN #: 6 One erroneous argument that I read often was because there was an externality it must be inefficient. This is not quite since there was an attempt to correct the externality. It is only when externalities have not been corrected at all that we can be certain that the outcome will be (to some degree) inefficient. Also, while people were good about paying attention to the 3 points indicated at the top of the page for question 8, this was consistently ignored on question 9. Based on Man cited for shooting a songbird June 7, 2002 By Holly Huffman Eagle Staff Writer To Kill a Mockingbird isn t just a critically acclaimed novel and movie. In Texas it s also a crime, as Washington County resident Shannon Dwayne Mitschke learned the hard way. The 32-year-old Mitschke was issued a Class C misdemeanor citation Wednesday for killing a mockingbird, the state bird of Texas, after he grew tired of its constant forays into his vegetable garden. Mockingbirds and other songbirds are protected by state law. Mitschke spotted the bird in his yard for the last time on Tuesday night, said Carlene Starr Davis, spokeswoman for the Washington County Sheriff s Department. Fed up, he grabbed his.4 shotgun, headed out the door and, according to the sheriff s department, dispatched the intruder. Mitschke may have thought he was done with the pesky creature. But his neighbors, avid bird watchers and members of the National Audubon Society, weren t willing to let the matter rest, Davis said. The couple was on the porch when the shooting occurred and watched as the dead bird fell into their yard. Aware that the Mr. Mitschke had killed the state bird of Texas, they reported the incident to the sheriff s department, which sent a deputy out to look at the carcass. Mitschke was surprised, Davis said, when the deputy came to his home to investigate the mockingbird s death. He said he shot the bird because it had been pecking at his vegetables and contaminating feed troughs for his livestock. I ve lost most of my tomatoes and broccoli already this year, explained the frustrated Mitschke. If I can t protect all my work, I m not going to bother anymore. Mitschke was issued the citation by a Texas Parks and Wildlife game warden who informed him that he could face a fine of up to $500 fine for killing the mockingbird or any other songbird or non-game bird in the state of Texas. The protected birds which include hawks, owls and eagles cannot be killed, removed from their nest, picked up, or possessed for any reason, Davis said. Even their feathers may not be possessed or sold. It s kind of a big no-no, Davis noted.