ECON 311 Midterm Fall 2007

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ECON 311: Economics of the Environment Name:________________

Fall 2007 Bellas

Midterm

You have three hours and twenty minutes to complete this exam. Answer all questions,

explain your answers, label axes and curves on graphs and do your own work. Fifty points

total, points per part indicated in parentheses.

1. List the steps that take us from production residuals (the stuff that is left over from

making goods) to pollution damage. The point of this question is not that I want you to

memorize such things, but rather that I want you to be able to think in an organized fashion

about how we go from production residuals to pollution damage that hurts people. (3)

Residuals > emissions > changes in ambient levels > (human) exposure > pollution damage

2. Some natural resources yield benefits in situ, or as they exist in their natural situation.

Imagine that there is some natural resource that yields benefits in situ as well as upon

extraction or harvesting. If this natural resource is privately owned, what is the primary

factor that determines whether the owner will harvest the resource or leave it in its natural

state? (3)

The important issue here is not whether the resource (such as a forest) provides greater

benefits in situ than it would in extraction, but rather whether the owner can capture

these in situ benefits. If she can capture enough of the in situ benefits, then the resource

will likely be left in its natural state.

Also, as one student pointed out:

“Also, in sit benefits to the owner involve a future value and uncertainty and discount

rate. Harvesting now gives a certain value.”

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3. Consider the following diagram showing the marginal value (MC) and the marginal cost

(MC) for trash disposal.

A. On the graph above, indicate the quantity of trash that people will throw away if, for a

monthly fee of $30, they can throw away as much as they want to. Label this Q0. (2)

B. On the graph above, indicate which area is the dead weight loss that results from the

system described in part A. (2)

C. Now, it is usually the case that when you charge people per unit of something, they will

consume less of that good or service. However, specifically consider a “pay as you throw”

system that charges people per volume of trash that they throw away. In addition to throwing

away less stuff, how might they respond to this sort of payment system? (2)

To get points for this you needed to tell me something specific about how people would

respond to the fact that this is a per volume system. The best answer would be that they

would compact their trash, either manually, using some sort of machine, or, even better,

using some sort of nuclear fusion process that compacted trash at the sub-atomic level,

creating a type of super dense, black-holish sort of material. However, the inherent

instability of these sorts of materials could yield some serious negative externalities.

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4. Explain why the issue of standing is important in determining the efficient level of

provision of a public good. (3)

Standing determines whose values are included in an analysis. The total marginal

willingness to pay or the total marginal value of a public good is the sum of the

individual marginal values of everyone with standing. As the set of people who have

standing expands, the total marginal value increases and the efficient level of provision

increases as well.

5. Show, on an appropriate graph, how the efficient level of abatement changes when the

marginal cost of abatement falls, perhaps due to some sort of technological advance. (3)

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6. Imagine that there are three people living on a lake and that cleanliness of the lake is a

public good that they share benefits from. The marginal cost of improved cleanliness and the

marginal value (or marginal willingness to pay) of each person for improved cleanliness are

as described in the following table:

Levels of

Improvement

MC

MVA

MVB

MVC

MVT 1 $ 5 $20 $15 $10 $45 2 $10 $17 $13 $ 9 $39 3 $15 $14 $11 $ 8 $33 4 $20 $11 $ 9 $ 7 $27 5 $25 $ 8 $ 7 $ 6 $21 6 $30 $ 5 $ 5 $ 5

A. What is the optimal number of levels of improvement? (2)

Four units. At this level the MVT of the fourth unit still greater than the MC.

B. Explain why one additional level of improvement would not be efficient. (2)

One additional unit wouldn’t be efficient because the marginal cost of the next unit

($25) is greater than the combined marginal value of all the people who have standing

($21). In other words, it’s not worth the cost.

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7. Consider a standard supply and demand diagram for some good such as sandwiches. In

your answers below, show and label all relevant curves and the dead weight loss.

A. Diagram a negative externality that results from the consumption of sandwiches. (2)

B. Diagram a negative externality that results from the production of sandwiches. (2)

C. Why might there be a positive externality associated with consumption of sandwiches?

(2)

Thanks to one student for this answer:

“If a person eats a delightful tasting sandwich they may be in a good mood and be more

pleasant to be around. The smell of the sandwich might cover up their morning breath

if they did not brush heir teeth that morning.”

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8. The old English windows tax was a property tax assessed against building owners based

on the number of windows their building had in it.

A. While this tax was very silly and resulted in some terrible responses by building owners,

explain why it might have been efficient at that time in history but would probably not be

efficient today. (3)

Thanks to a student for this answer:

“It was efficient at the time because it was (a) relatively easy/low cost method of

monitoring.”

B. Explain what this has to do with environmental economics and the design of

environmental regulations. (3)

And to that same student for:

“Environmental regulations mimic this idea by employing methods that utilize a low

cost or efficient method of monitoring.”

Also, as we get better at measuring something, we get better at properly regulating it.

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9. Two factories are each emitting eight tons of waste into a lake. The state’s pollution

authority would like to cut the total emissions by six tons. The factories have the following

marginal cost of abatement schedules:

Tons Abated MCA MCB

1 $1 $8 2 $4 $11 3 $7 $14

4 $10 $17

5 $13 $20

6 $16 $23

7 $19 $26

8 $22 $29

A. One way to reduce emissions by six tons would be to have each factory reduce emissions

by three tons. What would be the total cost of this? (2)

1+4+7+8+11+14 = $45

B. What per ton emission fee would result in six tons of reductions? (2)

As shown above, the lowest cost way of reducing emissions by six tons is to have A do

four tons and B do two tons. The marginal cost of the last unit abated is $11 and the

next highest marginal cost is $13, so this is the range of the emission fee, between $11

and $13.

C. Now, separate from parts A and B, if the marginal value of a ton of abatement is $18,

what is the efficient number of units of abatement to do? (2)

You should abate until the MC rises to $18, which would be 6 units for A and 4 units

for B, or a total of 10 units.

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10. Imagine that a project for which you are doing a benefit-cost analysis has a traditional

net benefits stream, meaning that the costs of the project are paid at the start of the project

while the benefits of the project come after several years. How will an increase in the

interest rate that is used to discount future values affect the net present value (NPV) of this

project? Will it this increase in the interest rate increase or decrease the NPV of the project?

Explain why. (3)

An increase in the interest rate will decrease the NPV of the project because it will

reduce the present value of the future benefits more than it will reduce the present

value of the more immediate costs.

As one student put it, “Because all of your costs are incurred in the beginning the

interest rate will not affect the costs, however the interest rate increase will decrease the

(present value of the) future benefits of the project which will lower your NPV.”

11. For the following diagram as it is drawn, indicate the efficient level of pollution

abatement. (3)

Because the leftmost area between the curves is greater than the rightmost area

between the curves, zero is the efficient level of pollution abatement.

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12. Imagine that you are trying to value a particular piece of wilderness that people use for

recreational hiking and cycling. While this area has no entrance fee, statistics have been kept

on who visits and how frequently they visit the area.

Visitors come from two cities. City A is 30 miles away and has 5,000 residents.

They make an average of 3 visits per year. City B is 50 miles away and has 100,000

residents. They make an average of 1 visit per year.

The cost of traveling is $0.25 per mile.

Using the travel cost method, estimate the annual active use value of this area to the people

living in these cities. (4)

City A: CS = ½ * (30-15) * 3 = $22.50 per person

City B: CS = ½ * (30-25) * 1 = $2.50 per person

$22.50*5,000 + $2.50*100,000 = $362,500.

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0. The first homework assignment in this class had three particularly bewildering questions

on it. I would like to review a couple of these questions briefly as a bit of a prelude to this

midterm.

A. The situation in which you are sharing hot water with your roommate is rather like going

to an all-you-can-eat restaurant, where you pay one price and then get to eat all the food that

you want for no extra charge. Explain what these situations have to do with environmental

problems. (2)

B. Family run businesses very often employ family members even though it isn’t necessarily

efficient to have those family members working there. Similarly, some hundreds of years

ago, England imposed a tax on windows despite the fact that this evoked a predictable and

very inefficient response from affected property owners; they boarded up many of their

windows. Explain what these situations have to do with each other and what they have to do

with environmental regulation. (2)

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1. My wife and I lived in Bulgaria for a year back in the early 1990s. This was a

tremendously cool experience for a variety of reasons, not the least of which was that I got to

work with an outstanding student named Anton Gavrilov. When he wasn’t studying, Mr.

Gavrilov had the responsibility of collecting payments for the hot water bills in the building

where he lived. About half of the apartments in his building had individual hot water meters,

and the occupants of those apartments paid for the amount of hot water that they used. Other

apartments had no individual meters. For these non-metered apartments, the total amount of

hot water use was divided by the number of apartments and each apartment paid for the

average amount used.

A. In which type of apartment was hot water use greater? Why? (1)

B. At that point in time, Bulgaria was having trouble paying for its purchases of fuel from

other countries. Explain how devices such as hot water meters could help to resolve this

problem. (1)

C. In the following graph, indicate the dead weight loss from people consuming hot water

without any sort of meter measuring their individual use. (1)

D. Apart from the fact that heating water usually generates some residuals, and that these

generally lead to some air pollution, what does this question have to do with environmental

issues? (1)

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2. We generally see that as women’s opportunities for employment and labor market

income increase, they tend to have fewer children. Explain why this is. (2)

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4. It's summer and water is scarce. The good folks of Sombertown are currently paying

$20/month for water service plus $5/hundred gallons consumed, but at this rate the reservoir

will be empty by August 1. Councilman Berger suggests using economics to solve the

problem and proposes doubling the monthly charge for water service to $40, saying, "If we

increase the price, the quantity demanded will fall and there will be enough water."

Councilman Kringle suggests increasing the charge for water usage to $15/hundred gallons,

saying, "This increase in price will reduce the demand and there will be enough water."

Clarisse, a local anarchist and schoolteacher, responds angrily by saying, "This is ridiculous.

Price is clearly irrelevant when talking about something as necessary to life as water. People

will continue to consume what they need regardless of the price."

Comment on each of these statements. Be sure to state whether you think the person making

the statement is right or wrong and why.

A. Councilman Berger (1)

B. Councilman Kringle (1)

C. Dr. Clarisse, Anarchist and Teacher (1)

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5. Consider the following diagram showing the relationship between the level of cleanliness

of a lake and the total value of that lake.

A. Draw in the associated marginal value curve on the lower set of axes. Please be careful

and clear in your diagram. (2)

B. Explain why, in diagramming marginal benefits of pollution reduction, we usually only

draw the downward sloping portion of the marginal benefits curve. (2)

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6. Now consider a diagram of the level of cleanliness of a lake. For the indicated marginal

cost (MC) and marginal benefit (MB) curves, please answer the following.

A. Of the levels of cleanliness indicated on the graph (A, B, C, D and E) which might be

optimal and which would never be optimal? (2)

B. How would you choose between two or more points that might be optimal? (2)

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7. I know you love the pollution diagrams. Consider this alternative model of how the level

of cleanliness affects the total value of a body of water.

Carefully draw in the associated marginal value function on the lower axes. (2)

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8. I know you love the pollution diagrams. Here is the diagram of the total value of a body

of water from the previous question, but in this diagram the total cost curve for achieving

those levels of cleanliness has been added.

Indicate the optimal level of cleanliness for this body of water, based on the total value and

total cost curves that are shown in the diagram. Remember, these are total value and total

cost, not marginal value and marginal cost. (2)

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11. Imagine that there are two people living on a lake and that cleanliness of the lake is a

public good that they share benefits from. The marginal cost of improved cleanliness and the

marginal value (or marginal willingness to pay) of each person for improved cleanliness are

as described in the following table:

Levels of

Improvement

MC

MVA

MVB

MVT

1 $ 5 $25 $15 $40

2 $10 $20 $10 $30

3 $15 $15 $ 5 $20

4 $20 $10 $ 0 $10

5 $25 $ 5 $ 0 $ 5

6 $30 $ 0 $ 0

A. What is the optimal number of levels of improvement if both people have standing? (1)

B. How will the cost be divided between Person A and Person B if each person is charged a

fee based on his total benefits from the optimal level of improvements? To put this more

clearly, how much, either in dollar or percentage terms, should Person A pay and how much

should Person B pay for these improvements? (1)

C. More generally, as the size of a community increases, what happens to the efficient level

of provision of public goods, other things held constant? (1)

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12. Imagine that an environmental regulation will reduce the supply of a particular good,

reducing gains from trade in that market. Further, imagine that demand for this good might

be relatively elastic (meaning that the demand curve is fairly flat) or relatively inelastic

(meaning that the demand curve is fairly steep).

A. If demand is relatively elastic, who will bear most of the burden of the supply reduction

in the market, consumers or producers? Explain or show this. (2)

B. Under which condition, elastic demand or inelastic demand, will the environmental

regulation be more likely to be defeated in a representative democracy? Explain your

answer. (2)

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13. We talked about four methods that economists might use to value the benefits of

programs that improve environmental quality. They were, in no particular order, the value of

a statistical live (VSL), hedonic property valuations (HPV), the travel cost method (TCM)

and contingent valuation (CV). For each of the following environmental programs, please

state which of these four methods would be the best to use in valuing benefits. No

explanation is necessary.

A. A program that would create a wilderness area in northern Wisconsin suitable for

backpacking and canoeing. (1)

B. A program that would reduce traffic noise from I-35W, running through parts of St. Paul.

(1)

C. A program that would reduce the levels of benzene, a dangerous but tasteless and

odorless contaminant, in drinking water around the Twin Cities metropolitan area. (1)

D. A program that would reduce emissions of very small particulates from diesel engines,

which cause thousands of premature deaths each year. (1)