EC465

First exam

Fall 2002

 

 

·        On the first page in your first blue book, please write out the honor code and sign your name. 

 

·        First read over the questions: if you are uncertain about any question, please ask for clarification. 

 

·        The exam begins at 9:30 and ends at 10:50, so you can take 40 minutes per question.

 

·        Please be specific when you cite and discuss the articles that we have studied. 

 

Good luck!

 

JTI

 

******

Section I – The Theory of Environmental Policy 

 

(ANSWER ONE QUESTION IN THIS SECTION – IA or IB)

 

A.     The Pigouvian and Coasian Perspectives

 

A bed-and-breakfast (B&B) owner in Vermont typically has seven guests per weekend, who each pay $200 per room for the weekend.  The B&B owner incurs costs of $700 if she is open on a weekend, or she incurs costs of $0 if she is not open.

 

A local dairy farmer owns a large field which is upwind of the B&B. For every additional 50 cows that the framer grazes in this field over the weekend, he earns an additional $1000 in revenue from milk sales.  The marginal cost of grazing the cows increases with the addition of every additional 50 cows.

 

When the farmer grazes more than 50 cows in the field, the resulting smell discourages guests from staying in the B&B.  Specifically, for every additional 50 cows in the field, the B&B owner loses another weekend guest.

 

Revenue and cost data for the dairy farmer and the B&B owner are summarized here:

 

Dairy farmer

B & B owner

 

Herd size

Marginal revenue

Marginal Cost

Total guest loss (rooms)

Marginal revenue loss

 

 

50

 $ 1,000

 $     100

0

 $           -  

 

 

100

 $ 1,000

 $     300

1

 $       200

 

 

150

 $ 1,000

 $     500

2

 $       200

 

 

200

 $ 1,000

 $     700

3

 $       200

 

 

250

 $ 1,000

 $     900

4

 $       200

 

 

300

 $ 1,000

 $ 1,100

5

 $       200

 

 

 

 

1)      Describe the externality in this situation.  Is it public or private, shiftable or non-shiftable, pecuniary or technological?  Justify your answers.    

 

2)      If a Pigouvian tax were imposed by the local government, how much should it be and who should pay it?  If such a tax were imposed, what would be (a) the profit for the farmer, (b) the profit for the B&B owner, and (c) the tax revenues for the government?  What would be society’s total net benefit?

 

3)      If there were no tax, and the dairy farmer had the ‘property right’ in this situation, what would be his profit?  What would be the B&B owner’s profit?  What would be society’s total net benefit?

 

4)      If there were no tax, and the B&B owner had the ‘property right’ in this situation, what would be her profit?  What would be the farmer’s profit?  What would be society’s total net benefit?

 

5)      A new technology is available that can eliminate the offending emissions from dairy cows, but in these circumstances it would cost $500 per weekend to use.  If the dairy farmer had the ‘property right’ in this situation (again, with no tax), would it be pareto-improving for the B&B owner to pay him $500 to adopt this technology?  If the B&B owner had the ‘property right’ in this situation, would it be pareto-improving for the farmer to pay $500 to adopt this technology?  Justify your answer.

 

6)      In ‘real life’ Vermont, do you believe that dairy farmers should be held liable for the externalities that they impose on the neighbors (including soil erosion and watershed degradation)?  Justify your answer.

 

B.  Tax- and permit-based climate policy.

 

The Intergovernmental Panel on Climate Change (IPCC) has determined that a $20 tax on each ton of carbon emissions would lead to the stabilization of global warming.  Two firms (1 and 2) will now be subject to this tax.  Prior to the imposition of the tax, Firm 1 was emitting 10,000 tons of carbon, and Firm 2 was emitting 12,000 tons of carbon. 

 

After the imposition of the tax (or alternatively, the permit-based regime described below), the following aspects of their profit-maximizing behavior do not change: levels of output production, the price of goods that they sell, and the costs of all other inputs.

 

The Marginal Abatement Cost (MAC) for Firm 1 is:

 

MAC = 0.02*A1 (where A1 is the number of units of abatement for Firm 1).

 

The MAC for Firm 2 is:

 

MAC = 0.01* A2 (where A2 is the number of units of abatement for Firm 2).

 

1)      Is global warming excludable or non-excludable?  Divisible or non-divisible?  Justify your answers.

 

2)      Under the new tax regime, how many tons of carbon will Firm 1 emit?  What will be their total cost of abatement?  What will be the total change in their profits since the imposition of the tax regime?

 

3)      Under the new tax regime, how many tons of carbon will Firm 2 emit?  What will be their total cost of abatement? What will be the total change in their profits since the imposition of the tax regime?

 

Alternatively, instead of a tax, let’s say that the IPCC recommends a permit-based regime.  They issue 9,500 permits to Firm 1 and 9,500 permits to Firm 2.  The market price of permits quickly stabilizes to $20. 

 

4)      Under this permit regime, how many tons of carbon will Firm 1 emit?  What will be their total cost of abatement?  What will be the total change in their profits since the imposition of the permit regime (compared to the original, non-tax regime)?

 

5)      Under this permit regime, how many tons of carbon will Firm 2 emit?  What will be their total cost of abatement?  What will be the total change in their profits since the imposition of the permit regime (compared to the original, non-tax regime)? 

 

6)      In the case of S02 reduction-policy, why did firms generally prefer a permit-based policy to a tax based-policy?  Justify your answer.

Section II – Economic analysis and sustainability

 

(ANSWER ONE QUESTION IN THIS SECTION – IIA or IIB or IIC)

 

A)    In ‘The Environmentalists are Wrong’ (The New York Times, August 26, 2002), Bjorn Lomborg writes:

 

Traditionally, the developed nations of the West have shown greater concern for environmental sustainability, while the third world countries have a stronger desire for economic development. … The challenge in Johannesburg [the recent world summit on the environment] will be whether we are ready to put development ahead of sustainability. If the United States leads the way, the world may finally find the courage to do so.

 

Do you agree with this statement by Lomborg – should we put development ‘ahead’ of sustainability?  Support your opinion with relevant material from our reading.

 

 

B)  In ‘The Economic Theory of a Common-Property Resource,” (The Journal of Political Economy 62(2):124-42),  Scott Gordon writes:

 

Many [biologists] … have recognized that the ultimate question is not the ecology of life in the sea as such, but man’s use of these resources for his own economic purposes.  Dr. Martin Burkenroad, for example, began a recent article on fishery management [by] saying that “the management of fisheries is intended for the benefit of man, not fish; therefore effect of management upon fishstocks cannot be regarded as beneficial per se.”

 

Do you agree with Gordon and Burkenroad – should the economic benefits of humans guide the management of fisheries?  Support your opinion with relevant material from our reading.

 

 

C)  In “A Tale of Two Fisheries” (The New York Times, August 27, 2000), John Tierney quotes Rhode Island lobsterman John Sorlien:

 

“If we get some kind of environmental disruption that interferes with reproduction one year, we'll end up with nothing to catch for a whole season. We just go from year to year not knowing what to expect. I don't have a clue what kind of year this will be for me. It's like we're backing up to the edge of a cliff blindfolded, and we don't know if we're 50 feet away or have two wheels over the edge.”

 

How do Sorlien’s comments illustrate the weaknesses of economic analysis as it applies to the management of ecosystems?  Support your opinion with relevant material from our reading.