Economics 5250/6250 Dr. LozadaFall 2012 Midterm Exam

This exam has 33 points. There are six questions on the exam;you should work all of them. Half the questions are worth 5 pointseach and the other half are worth 6 points each.

Put your answers to the exam in a blue book or on blanksheets of paper. The figure for the exam appears after the ques-tions.

Answer the questions using as much precision and detail as thetime allows. Correct answers which are unsupported by explana-tions will not be awarded points. Therefore, even if you thinksomething is “obvious,” do not omit it. If you omit anything,you will not get credit for it. You get credit for nothing whichdoes not explicitly appear in your answer. If you have questionsabout the adequacy of an explanation of yours during the exam,ask me.

Answer all of the following questions.

1. [5 points] Define “assimilative capacity” and draw a graph of a Mar-ginal External Cost Curve if the environment has a (strictly positive)assimilative capacity for a pollutant. Be sure to explain your graph.

2. [6 points]

(a) Placing the output Q of a polluting commodity on the horizontalaxis, graph a typical marginal net private benefit curve (“MNPB”)and marginal external cost curve (“MEC”).

(b) If the polluter possesses all the property rights, show the valueof Q. Assume no bargaining.

(c) The position of the MEC curve shows how changes in Q affectmarginal external cost holding everything else fixed, where “ev-erything else” includes the pollution victims’ income. How wouldyou guess MEC would change if pollution victims’ income were tofall? Why? [By the way, we did not discuss this in class, but youshould be able to figure it out anyway.]

(d) In class, we argued that if the polluter possessed all the propertyrights, Coasian bargaining would result in Q going to where theoriginal MNPB and MEC curves intersect. Why does your an-swer to part (c) of this question throw doubt on that conclusion?[Again, we did not discuss this in class, but you should be able tofigure it out anyway.]

3. [6 points] ”Marginal Cost” is the derivative of Total (internal) Costwith respect to output Q. Argue that giving a subsidy to pollutingfirms to decrease their output can be interpreted as an increase in suchfirms’ marginal cost. Use the following equation in your answer (andexplain this equation):

Post-subsidy NPB(Q) = NPB(Q) + σ(Qmax −Q).

4. [5 points] Contrast the efficiency of a tax and of a marketable permitscheme, using Figure 1.

5. [5 points] On October 24, 2012, the Denver Post carried an arti-cle under the headline “NOAA: Ozone hole at 2nd smallest size in 20years.” The first three paragraphs of the article were:

1

The ozone hole over the Antarctic is the second smallest ithas been in the last 20 years, according to data from NASA andNational Oceanic and Atmospheric Administration satellites.

Scientists who work on the ozone-monitoring project believeslightly warmer temperatures in the lower stratosphere contributedto the smaller hole in the ozone layer this fall, but the results alsoindicate progress in reducing harmful chlorine compounds in theatmosphere.

“It shows that we’re on the right track,” said Bryan John-son, an atmospheric chemist for NOAA in Boulder and projectmanager for ozonesonde, the program that measures ozone overAntarctica. “We’re going to be getting smaller and smaller ozoneholes for the next 30 or 40 years until, in 50 years, we won’t haveany ozone hole to speak of.”

State as many reasons as you can for why “progress in reducing harmfulchlorine compounds in the atmosphere” has happened.

6. [6 points] What does the interest rate have to do with intergenera-tional equity?

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