EC465
First exam - answers
Fall 2003
Section I – The theory of environmental policy
(ANSWER ONE QUESTION IN THIS SECTION – IA or IB)
A. Correcting for
externalities
In a large city with
many aspiring young musicians, an aspiring opera singer has the choice each day
(from 9:00 AM to 5:00 PM) between (a) singing in a municipal subway station
(where she is forbidden by law from collecting change from the subway riders)
or (b) teaching grade-school students, where she can earn $40 per hour.
A municipal worker
implements a survey of subway passengers, and estimates that, on average, each passenger receives approximately $0.50 of
benefit per hour from opera singing (because their utility is increased by the
high-quality music). The survey also
shows that, on average, 60 passengers pass through this subway station per hour
when there is no opera singing, and 90 passengers pass through this
subway station per hour when there is opera singing. The municipal
government charges $1 per subway ride, which is its marginal cost per
passenger.
1) What is the opportunity
cost (per hour) for the opera singer if she elects to sing in the subway
station? Justify your answer.
2) Describe the externality in
this situation. Is it public or private,
shiftable or non-shiftable, pecuniary or technological? Justify your answers.
This is a
public, non-shiftable, technological externality. See the definitions in the Baumol and Oates reading.
3) In a graph with $$ on the
vertical axis and subway rides on the horizontal axis, illustrate two possible
equilibria in this market: (a) when there is no
opera singing; and (b) when there is opera singing. Without government intervention, which will
be the long-run equilibrium? Justify
your answer.
The two
possible equilibria are illustrated above.
The first equilibrium, Q= 60 and P = $1, is the equilibrium that will occur
without government intervention.
4)
If
the municipal government imposed a Pigouvian
prescription in this situation, what would it be, and how much should it
be? Would the Pigouvian
prescription be pareto-improving? Justify your
answers.
The potential
Pigouvian prescription is to subsidize the
activity that is producing the positive externality (as opposed to taxing
an activity that produces a negative externality). And the amount of the subsidy should be equal
to the dollar value of the positive externality. So in this case, since we know from survey
data that 90 customers would use the subway per hour and each of them would get
$0.50 of benefit per hour, we should
subsidize the singer with $45 per hour. This would be pareto-improving, since it is aligning the marginal cost of
singing with the marginal benefit of singing.
(One can also show graphically that this solution increases consumer
surplus, while transferring money – which is neither an
increase or decrease of social welfare -- from the government to the
singer)
5)
If
the municipal government imposed a Coasian prescription in this situation, what
would it be? Would the Coasian
prescription be pareto-improving? Justify your answers.
One Coasian
prescription would be to permit collecting
change from subway riders, and then have consumers pay to hear her sing. Of course, however, the temptation to
free-ride would be intense: that is, for each rider to not pay the $0.50 worth of
benefit that they are receiving from hearing her sing. How to get over this, in a Coasian
fashion? Perhaps erect a sound-proof area
in which the singing occurs, and which requires an additional $0.50 entrance
fee. Or more simply, to charge $1.50 for
the use of this subway station!
6)
Would
your answers to any of the questions above (1 - 5) change if the opera singer
received a great deal of utility from signing in the subway? Justify your answers.
Her
opportunity cost would change is she got lots of utility from singing (this is
the equivalent of the fishermen and fisherwomen who love fishing so much that
they will do it even when they are losing money.) As noted above, if she is willing to sing at
the amount equal to the dollar value of the positive externality, this is a pareto-improving solution.
But if her utility is so high from singing that she would accept less,
this is also a pareto-improving solution. The final amount that is
negotiated – from $45 on down – doesn’t change the net social welfare, however,
since this is just a transfer payment.
B. Solutions to the tragedy of the commons
You are one of 10 indigenous harvesters of a tropical forest. For every day that you and the other 9 people harvest in the forest, you each forego a wage of 100 pesos in the neighboring town.
Every day, you and each of the other harvesters can choose to harvest 1 tree, 2 trees, OR 3 trees. Your profit function can be expressed by the following table, where the first number in parentheses is your accounting profit (in pesos), and the second number is the accounting profit of each of the other 9 harvesters.
|
Revenues from tree harvesting |
|
||
|
|
|
|
|
|
|
Other 9 players harvest (in total) |
||
|
You harvest |
9 trees |
18 trees |
27 trees |
|
1 tree |
(300,300) |
(200,350) |
(100,200) |
|
2 trees |
(350,200) |
(250,250) |
(150,100) |
|
3 trees |
(200,100) |
(100,150) |
(50,50) |
Each of the other 10 harvesters
faces the same profit function
1) How many trees would be harvested if a single person owned the forest, and
she paid each harvester a wage of 100 pesos?
Justify your answer.
This is
of course analogous to the CPR situation in a fishery. A single owner would maximize profits, which is
where each harvester takes 1 tree (for a profit of 10*(300 – 100) = 2,000
pesos.
2) According to Garret Hardin, how many trees would be harvested if this
were an open access forest? Justify your
answer.
Each
harvester, in a tragedy of the commons, would make their optimal decision, conditional
on the possible choices of the other harvesters. In this case, that decision is
2 trees (e.g, 350 > 300 > 200, if the other 9
players harvest 9 trees)
3) According to Elinor Ostrom,
how many trees would be harvested in the presence of a central authority with complete
information? Illustrate how such a
solution would lead to a pareto-improving
outcome.
4) According to Elinor Ostrom,
how many trees would be harvested in the presence of a central authority with incomplete
information? Illustrate how such a
solution might not lead to a pareto-improving
outcome.
5) Following the analysis of Elinor Ostrom, explain how a ‘self-financed contract enforcement’
could also lead to the pareto-optimal outcome. What is the most that each harvester
would be willing to pay to enforce such a ‘self-financed contract
enforcement’? Justify your answer.
6) Is the solution described in 1) – ownership by a single person –
superior to the solution described in 5) – the ‘self-financed contract enforcement’? Justify your answer.
Section II – Environmental economics and
cost-effective policies
(ANSWER ONE QUESTION IN THIS SECTION – IIA or IIB)
A) Poverty, sustainability and natural resource
extraction
In
Slate last week, Nancy Palus reports (October 13, 2003);
Chad,
landlocked in the middle of Africa and one of the poorest countries on the
planet, joined Africa's group of oil producers Friday when African leaders,
World Bank officials, and hundreds of other invitees attended the formal inauguration
of the 650-mile pipeline from southern Chad to a port in neighboring
Cameroon. The World Bank-backed project
takes a novel approach, incorporating strict anti-corruption measures to ensure
that oil wealth be used not to enrich an elite few but to improve the lives of
average citizens.
The
Chad-Cameroon pipeline, at full production, is expected to pump about 225,000
barrels per day for shipment across the Atlantic. This oil is expected to bring
in more than $80 million per year to Chad, which currently ranks 165th
of 175 countries in the U.N. human development index and where corruption is
said to be rampant.
But
a coalition of environmental and aid organizations dubbed Friday a
"national day of mourning," arguing that widespread oppression and
insecurity in Chad will only be exacerbated by the oil project: “'Black gold'
in Africa, which represents 7 percent of the world's reserves, has more often
left a legacy of miserably low wages and living conditions for oil workers and
their families, of conflict and corruption, and no economic development."
This
legacy is what the World Bank wants to reverse with its innovative scheme to
place Chad's oil revenues under tight scrutiny, the bulk of the wealth going
toward the country's infrastructure. Specifically, Chad's oil revenues will be
put into an escrow account in London, "where the bank will take 5% to pay
back loans before the rest is earmarked for good works under the watchful eyes
of an independent monitoring panel." Under the World Bank plan, the money
for Chad is to be divided among an account for future generations (10 percent),
development of the Doba basin region that houses the
main oilfields (5 percent), and national projects in health, education, roads,
and water supply (80 percent). Chad has
established a panel to ensure that funds are allocated according to these
parameters, but environmentalist activists have protested that the group is
dominated by people close to the Chadian president.
If you were a representative
of an environmental or aid organization, would you support this World
Bank-backed project? Why or why not?
What efforts should be made to improve this project? Support your opinion with relevant material
from our reading, including but not restricted to Solow.
B) The tragedy of the world’s fisheries
In ‘The Tragedy of the Commons’, Garret Hardin writes (p.
11):
The tragedy of the commons as a food basket is averted by private property, or something formally like it. But the air and waters surrounding us cannot be readily fenced, and so the tragedy of the commons [in the case of air and water] must be prevented by different means
In Governing the Commons, Elinor
Ostrom writes (p. 13):
In regard to
non-stationary resources, such as water and fisheries, it is unclear what the
establishment of private rights means.
The ‘tragedy of the commons’ has proved particularly difficult to
counteract in the case of marine fishery resources where the establishment of
individual property rights is virtually out of the question. In regard to a fugitive resource, a diversity
of rights may be established giving individuals rights to use particular types
of equipment, to use the resource system at a particular time and place, or to
withdraw a particular quantity of resource units (if they can be found). But even when particular rights are unitized,
quantified and salable, the resource system is still likely to be owned in
common rather that individually. Common
ownership is the fundamental fact affecting almost every fishery regime.
Do
you agree with Hardin’s and Ostrom’s assessments
here? Why or why not? Support
your opinions with relevant material from our reading, including but not
restricted to Hardin and Ostrom.