ECON 3705: Environmental and Natural Resource Economics



ECON 3705: Environmental Economics

Study Guide for First Midterm

Major Topics:

1) Introduction and Basic Principles

a. Efficiency and Why Nothing is “Priceless”

b. Demand

i. Calculating benefits

ii. Calculating market demand from individual demand curves

c. Supply

i. Calculating costs

d. Calculating equilibrium price and quantity

e. Net benefits and deadweight loss

3) Market Failure

a. Public goods

i. Characteristics

ii. How to find market demand

iii. Efficient provision

iv. Free-rider problem

b. Externalities

i. Whether something will be done and whether it’s good for society

ii. Determining external cost

iii. Market price and quantity vs. socially efficient prices and quantity iv. Deadweight loss associated with market outcome

c. Coase Theorem

i. Assumptions and expected outcome

ii. Willingness to pay and willingness to accept

d. Tragedy of the Commons

i. What it is and how it can be addressed.

4) Efficiency

a. Issues with Benefit Estimation

b. Present Value and the Discount Rate

5) Valuing the Environment - Methods

a. Components of valuation

i. Use, option, and non-use values

b. Contingent valuation

i. 4 potential sources of bias

c Contingent ranking

d. Travel cost method

e. Hedonic estimation

i. Interpreting regression results

f. Value of a statistical life

i. How it’s estimated

ii. Moral questions

6) Overpopulation

a. Where things currently stand

i. Birth rates, fertility rates, and the replacement rate

a. Thomas Malthus – principle of population

b. Population growth and economic development

i. Law of diminishing returns

ii. Relationship between marginal productivity and average productivity

iii. Technology and economies of scale

c. Economic development and population growth

i. Theory of demographic transition (three stages)

ii. Why does population growth differ between income groups?

d. Microeconomics of fertility

i. Policies to alter MB curve

ii. Policies to alter MC curve

Note: The test will consist of approximately 20 multiple choice and 7-8 short answer questions. The practice problems are intended just to get you thinking about some of the topics you’ll be asked about on the exam. The questions are not exhaustive, so you should also use the book/notes/assignment to study. Enjoy the questions!

1. Suppose demand is given by P = 250 – 0.2Q and supply is given by P = 20 + 0.1Q.

a. Calculate the equilibrium price and quantity in this market.

b. Calculate the consumer and producer surplus associated with the equilibrium.

2. Suppose there is a negative externality associated with the good described in #1. The external costs are given by MEC = 0.05Q.

a. What is the efficient equilibrium price and quantity in this market?

b. What is the area of deadweight loss associated with the equilibrium quantity?

3. What are the two characteristics of public goods? What are the characteristics of private goods and common resources?

4. Describe how to calculate aggregate demand for a public good and for a private good given individual demand curves.

5. Demand curve for a public good is given by P = 40 - .125Q.

a.) If there are 30 individuals with this demand in the market, what is the aggregate demand?

b.) If the marginal costs of providing this public good are constant at $15, what is the efficient level of provision?

c.) Suppose 15 people are free-riders. What is the deadweight loss associated the under-provision of this good?

6. The social benefit of producing a unit of a good equals $20 and the social cost equals $15.

The private benefit equals $18 and the private cost equals $15. Does this represent a positive or negative externality? Can we expect this good will be produced or not? If it were produced, would it be good or bad for society?

7. Use the diagram below representing a negative externality to answer the following question.

[pic]

a) What is the expected market quantity (without government intervention)?

b) What is the socially optimal quantity in this market?

c) What is the area of inefficiency associated with the market outcome.

d) Describe how the market can arrive at the socially optimal quantity.

.

8. Refer to the diagram above reflecting a market with a positive externality.

a) What is the expected market price and quantity in this market (without government

intervention)?

b) What is the efficient (socially optimal) quantity in this market?

c) What is the external benefit associated with the 40th unit?

d) What is the deadweight loss associated with the market outcome?

9. With a negative externality present, the market quantity is too _________ compared to the efficient quantity, and so the government should apply a __________.

10. With a positive externality present, the market quantity is too ________ compared to the efficient quantity, so the government should apply a ___________.

11. What conditions are necessary for us to rely upon the "Coasian" solution to achieve efficient allocations with respect to production levels of pollution-generating goods? Does this mean we don’t need the government to force individuals or firms to account for externalities? How is the “Coasian” solution tied to the “Tragedy of the Commons”?

12. Assume that the demand curve for a particular food is fully coincident with the marginal social benefit function and can be described by MSB=MPB= 240– 2q, where q refers to the quantity in thousands of the good. Assume that the marginal private costs function can be described by MPC = q, and the marginal social costs are always double the marginal private costs (MSC=2q).

a. Calculate the inefficiency associated with market level of output.

b. What is the efficient Pigouvian tax?

c. If those who are affected by the externality have the property rights, what is their minimum willingness to accept the externality for the 1st unit? What is the firm’s maximum willingness to pay for the 1st unit? Calculate the same values for Q=240.

13. What is the present value of $50 million in 20 years if the discount rate is .05? What if the discount rate is .02?

14. Explain the differences between use, option and existence values. Which valuation method(s) can measure all three?

15. Describe the basic methods of valuation used in contingent ranking, averting expenditures and travel cost methods.

16. List four problems (biases) with contingent valuation method of estimation.

17. In response to acid rain damage to Chesapeake Bay, a collaborative federal and state program has been proposed. You have been hired to evaluate the benefits of the plan as part of a formal benefit-cost analysis. Use the travel cost method to accomplish this goal based upon the following pre- and post- policy demand functions:

Pre – policy: P = 72 – 0.04V

Post – policy: P = 90 – 0.04V

Where V is the number of visitors and P is the price to consumers.

a. The price to consumers is constant at $20, both pre- and post- policy.

b. The price to consumers is constant at $30, both pre- and post- policy.

c. The price to consumers is $20 pre- policy and then rises to $30 post-policy.

18. The following represents the estimated results from a hedonic equation:

Y = 200,000 + 4,500*X1 + 300*X2 – 2,500*X3 (+-) B4*X4

Where:

Y is the market price of a home

X1 is the number of bathrooms

X2 is the size of the lot in square footage

X3 is the age of the home

X4 is distance to a landfill

a. Explain the meaning of the coefficient on X1, the number of bathrooms.

b. What do you expect for the value of the coefficient on X4?

c. Suppose Y were given as the natural log of the market price of a home. How would you interpret the coefficient on X4.

d. Name two other variables that might be relevant to include as explanatory variables in this equation.

19. Suppose that on average, truck drivers are willing to accept a 1/2000 annual risk in death if

their income increases by $5000 annually. What is their collective willingness to be

compensated to accept the loss of a life?

20. Use the following results of a hedonic regression equation to answer a. - e.

Yi = Annual Salary

X1 = Years of education

X2 = Years of work experience

X3 = Location – Metropolitan Area

X4 = Number of fatalities/1,000 workers

ei = Error

Yi = ( + (1 * X1 + (2 * X2 + (3 * X3 + (4 * X4 + ei

Yi = $20,000 + $1,200 X1 + $500 X2 + $6,000 X3 + $4,300 X4 + ei

a. Interpret the coefficient (1.

b. Calculate the predicted salary of someone with 14 years of education, 10 years of work experience, not in a metropolitan area, on a job with a 6 fatalities/1,000 workers.

c. If this person actually makes $55,000, what is the error term?

d. What is the value of statistical life?

e. Suppose a policy would save 5 statistical lives/year costs $20 million/year. Do the economic benefits justify these costs? Explain.

21. One of the many critiques economists have faced as a result of calculating the value of a statistical life is that when analyzing data from different countries, we will inevitably estimate different measures for the value of a single life. For example, the value of a statistical life is significantly higher in the U.S. than in China. First, explain why this is the case (why is the value of a human life typically higher for in developed countries compared to under-developed or developing countries?). Second, discuss, briefly, whether you believe this is fair and appropriate (do you think it would be better for us to use a single international measure for a statistical life or to allow the measure to vary across nations in determining policies?).

21. Explain why Thomas Malthus predicted overpopulation would result in mass starvation and misery? What was the major flaw in his theory?

22. Under what condition(s) will population growth lead to a reduction in per-capita income? Under what condition(s) will population growth lead to an increase in per-capita income?

23. On a clearly labeled set of axes, graph the birth rate and death curves associated with the Theory of Demographic Transition. Also point out where the approximate cutoff points are for the three stages directly on your graph.

24. What indirect methods can policymakers use to try reduce population growth? What can they use to try to increase population growth?

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Social Costs

50 70 80

P

A A

A

B

C

D

E F

Q

PMB=SMB =Demand

Private Costs = Supply

P

PC=SC

14

11

8

6

8

SB

PB

25 40

0

100

70

Q

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