EC 307 Summer Flexi Tutorial 2 - Solutions

---------------------------------------------------------------------------------------------------------------------
EC307 : Resource and Environmental Economics

Summer Flexi Tutorial 2 Solutions
---------------------------------------------------------------------------------------------------------------------
Question 1
Using the theory of public goods, discuss the logic of why in some resort communities, the
ownership of waterfront homes also includes some defined area along the beach.
Typically, beaches are public goods (though not pure public goods). Characteristics of pue public
goods are nonrivalness and nonexcludability. However, the absence of property rights can lead to
problems like littering. One way to avoid this problem is to assign these rights to owners of
nearby resort homes. In so doing, those areas become private goods, and the problem of free
ridership is avoided.
Question 2
Discuss the four general property rights regimes and how they create different incentives
for resource use (or misuse).
 Under private property regimes, individuals hold entitlements.
 Under state-property regimes, governments own and control property (e.g., some parks
and forests).
 Common property regimes are those in which property is jointly owned and managed by
a specific group. Common property regimes are quite variable, but many result in
overexploitation of the resource. Over-fishing in local fisheries or over-hunting can be
good examples. A few successful examples exist such as the system of allocating grazing
rights in Switzerland.
 Under res nullis or open access regimes, no one owns or exercises control over the
resources. This type of regime leads to the “tragedy of the commons” because the
resources can be exploited by whoever can get to them first.
Common pool resources are characterized by non-exclusivity and divisibility. These
characteristics allow the resource to be exploited by anyone. Access cannot be denied, and
the amount captured will be eliminated from the original amount available (divisibility).
Unrestricted and unregulated groundwater withdrawal, and high seas fisheries are all
examples of resources that share the characteristics of common pool resources and the
tragedy of the commons.
Question 3
Use the following graph of the refined petroleum market to answer the questions
below.
$ per barrel MEC
A D
B C
0 QE QC Q (thousands of barrels)
M
a) Give the economic interpretation of each of the labeled areas: A, B, C, and D.
The economic interpretation of each area is as follows:
A Represents the net gain accruing to petroleum refineries (i.e., the excess
of their increased profits over the external damages to
recreational users), as they negotiate to increase production from
0 to output level QE.
B Represents the total amount of environmental damage associated with
producing output level QE.
C Represents the loss of profit to petroleum refiners from reducing output
from QC to QE.
D Represents the net gain accruing to recreational users (i.e., the excess of
the reduction in damages over the profit loss incurred by
producers), as they negotiate to achieve a reduction in output
from QC to QE.
b) Which area represents the loss to the petroleum refineries as a result of the restoration
of efficiency?
The loss to petroleum refiners as a result of the restoration of efficiency is represented by
Area C.
c) Which area represents the net gain to society? Should the reduction in output from QC
to QE take place? Why or why not?
Area D represents the net gain to society. Yes, the reduction should take place to achieve an
efficient allocation of resources. This improvement is evidenced by the fact that the net gain
is positive.
d) Describe the bargaining process between the refineries and the recreational water
users, assuming the refineries have the right to pollute.
If the refiners have the right to pollute, they will produce QC. At this point,
recreational users have an incentive to pay the refinery not to pollute as long as the
payment is less than the MEC they incur at the competitive equilibrium. Refiners have
an incentive to accept the payment as long as it is greater than their M at QC. Both
conditions hold all the way up to the efficient equilibrium, QE = 128, where the MEC =
M, and negotiations cease.
Question 4
A chemical pesticide producer releases waste into the nearby River. Because the negative
effects are not captured by the private market, there is a market failure, which is
illustrated by the following functions, where Q is the amount of liquid chemical pesticides
in thousands of barrels, and P is the price per barrel:
MSB = 70 ‒ 0.1Q MPC = 10 + 0.4Q
MEC = 0.1Q
a) Find the competitive equilibrium and the level of Mπ at that point.

The competitive equilibrium occurs where MPB = MPC, or where 70 ‒ 0.1Q = 10 +
0.4Q. Solving for output yields QC = 120 thousand barrels, and PC = $58 per barrel. By
definition, Mπ at the competitive output level is zero.
b) Find the efficient equilibrium and the Mπ function at that point.
The efficient equilibrium arises at the point where MSB = MSC, which in this case occurs
where 70 ‒ 0.1Q = 10 + 0.5Q, or where QE = 100 thousand barrels, and
PE = $60 per barrel. At the efficient equilibrium, Mπ is equal to the MEC. Therefore,
Mπ = 0.1Q at QE, or $10per barrel.
Question 5
Assume that a small town uses a referendum to overcome the free-ridership problem and
determine how its residents might value a new water filtration system for its public water
supply. The voting results are aggregated by the town’s two districts, yielding the following
demand estimates:
District 1: Q = 160 – 20P1
District 2: Q = 60 – 5P2,
where Q is the expected percent of copper to be filtered by the system, and P is the price
in millions of dollars.
a) Based on these estimates, determine the town’s market demand for this public good,
the new filtration system.
Because this is a public good, the two demands must first be written in inverse form and
then summed up. The reasoning is that, for a public good, each demander is expressing a
willingness to pay for the same quantity. The inverse demand equations are:
P1 = 8 – 0.05Q
P2 = 12 – 0.2Q
Summing these yields the market demand, which is P = 20 – 0.25Q
b) If the market supply for the system were P = 6 + 0.15Q, what would be the
equilibrium price and quantity for the town?
Equate the market demand and market supply and solve, as follows:
20 – 0.25Q = 6 + 0.15Q
0.4Q = 14
QE = 35 percent
Substitute QE into either equation to find PE as follows:
PE = 20 – 0.25(35) or 6 + 0.15(35) = $11.25 million
Question 6
A textile mill releases pollution into nearby wetlands, and the associated health and
ecological damages are not considered in the private market. Suppose you are an
environmental economist working with the following marginal benefits and costs for this
market, where Q is thousands of pounds and P is price per pound.
MPB = 800 – 0.5Q MPC = 20 + 0.3Q
MEB = 0 MEC = 0.4Q
a) Find the competitive equilibrium, QC and PC, and the efficient equilibrium, QE and PE.
Competitive equilibrium is found where:
MPB = MPC
800 – 0.5Q = 20 + 0.3Q
0.8Q = 780
QC = 975 thousand pounds
PC = 800 – 0.5(975) or 20 + 0.3(975) = $312.50
Efficient equilibrium is found where:
MSB = MSC
800 – 0.5Q = 20 + 0.7Q
1.2Q = 780
QE = 650 thousand pounds
PE = 800 – 0.5(650) or 20 + 0.7(650) = $475
b) Suppose the textile mill owned the rights to the wetlands, and it is negotiating with a
private environmental group that is willing to pay the mill to produce less output.
For the 800th unit of output, determine the range within which a payment would be
acceptable to both parties.
The acceptable payment, ,must be greater than the forgone marginal profit to the mill
associated with the 800th unit of output but less than the marginal external damage to the
wetlands incurred by the environmental group. That is,
MEC >  > M, where M = MPB – MPC = 780 – 0.8Q
Substituting the values results in the following:
0.4(800) >  > 780 – 0.8(800)
or 320 >  > 140
We conclude, therefore, that the payment must be between $140 and $320 per pound to
be acceptable to both the textile mill and the environmental group.

EC 307 Summer Flexi Tutorial 2 - Solutions

Uploaded by

Copyright:

Available Formats

EC 307 Summer Flexi Tutorial 2 - Solutions

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

EC 307 Summer Flexi Tutorial 2 - Solutions

Uploaded by

Copyright:

Available Formats

---------------------------------------------------------------------------------------------------------------------

EC307 : Resource and Environmental Economics

a) Find the competitive equilibrium and the level of Mπ at that point.

You might also like