MIDTERM EXAM
Johns Hopkins University
Environmental and
Resource Economics
Succinctness is appreciated. If a question seems ambiguous, explicitly state any
assumptions you need to make to answer the question.
QUESTION ONE. (Total Points: 12) Answer two of the three questions below. Each
question is worth 6 points.
1) In many tropical rainforests around the globe, it is not uncommon that entitlements to
the use of land are frequently “possessary” rights rather than “ownership” rights. In
other words, those on the land can use it as they wish, but they cannot transfer it to
anyone else. One can acquire a new plot by simply occupying and using it, leaving
an old plot available for someone else. Would this type of entitlement system cause
more or less incentive to conserve the rainforests than ownership entitlement? Why?
Use the four characteristics of efficient property rights to answer the question.
2) A demand function exhibiting constant elasticity generally takes the following form:
where P denotes the price, Q the quantity demanded, A a positive constant, and ε
the price elasticity of demand coefficient (with demand, ε < 0), a constant. Show
that the elasticity, , is a constant.
3) All “open access resources” such as ocean fisheries are public goods. True or false?
Why or why not?
QUESTION TWO. (Total Points: 12) Answer the following four questions below. If
you decide to use diagrams, they should be neatly drawn. On all diagrams, please label
your axes and curves. Each question is worth 3 points.
Background: Two firms can reduce emissions of a pollutant at the following marginal
costs:
MC1 = $6q1 MC2 = $2q2
where q1 and q2 are, respectively, the amount of emissions reduced by the first and second
firm. Total pollution-control cost functions for the two firms are, respectively:
TC1 = $5+$3(q1)2 TC2 = $5+$1(q2)2
Assume that with no control at all, each firm would be emitting 10 units of emissions (for
aggregate emissions of 20 tons), and assume that there are no significant transaction costs
to implementing an emissions control program that reduces emissions.
(1) What are the total industry costs of pollution control (i.e., for both firms
combined) if a uniform emission standard is utilized to achieve an aggregate
emission reduction of 6 tons? In other words, each firm is required to reduce
emissions by 3 units. What are the marginal costs of pollution control for firm #1
and for firm #2 under the standard?
(2) Assume that the pollution control authority establishes an emission-trading
program and that each firm is freely allocated 7 tons of emissions reductions.
What is the cost-effective reduction of pollution by the two firms with a tradable
permit approach? What are the marginal costs of pollution control for firm #1 and
firm #2? What are the total costs of the emission-trading program?
(3) Suppose that the pollution control authority decides to reach its objective of 6 tons
of aggregate emissions reduction with an emission charge instead of the use of
uniform standards or an emission-trading program. What per-unit charge on
emissions should the pollution control authority impose? How much government
revenue will the tax system generate, if the tax is levied on all units of emissions?
(4) Which policy instrument--taxes, tradable permits, or a uniform standard--would
you expect private industry to prefer (e.g., private industry as a whole, as well as
individual firms), assuming the regulatory goal of achieving an aggregate
emission reduction of 6 tons in the case considered above? Why?
QUESTION THREE. (Total Points: 11) If you use diagrams, they should be neatly
drawn. On all diagrams, please label axes and curves. Answer three of the four questions
below. Each question is worth 4 points.
Background: A State Environmental Regulatory Agency is thinking about establishing a
program to reduce pesticide use on farms by subsidizing farmers in the State to produce
less agricultural crops. The expressed goal of the program is to lower total pesticide
levels in the water bodies of the State.
The Agency is given the following information about the individual farms that would
produce agricultural commodities in the State. Each farm sells its crops (q) in a perfectly
competitive market. The price of each farm’s output is given by P. The costs of
producing agricultural commodities by each farm is given by C(q). Each farm’s marginal
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costs increase at an increasing rate as they produce more crops, in other words, C′ 0 , C′′
0 .
For purposes here we assume that each farm receives a subsidy for selecting a level of
crop production that is below from fixed output (i.e., crop) level set by a regulator, whose
goal is to achieve lower concentrations of pesticides in the State’s water bodies.
Let the subsidy equal S = α ( q - q)
where α = βD' represents the marginal social costs (i.e., the damages caused
by the pesticides that the farms are emitting) of producing q, and β is an
emissions coefficient linking pesticides to the amount of output the farms
produce;
q in this case represents the output that the farm would produce in the
marketplace in the absence of the any policy on subsidies to reduce pollution
if q = q , the producer receives no subsidy, S = 0
(1) Given profit-maximization as the goal for a typical farm, how would marginal costs
of producing output change with the subsidy program for a representative farm?
How would a representative farm’s average costs change with the subsidy program?
Explain what effect the subsidy would have on the representative farm’s marginal
and average costs and its supply curve in the short run.
(2) Consider the long run. What effect would the subsidy program have on the long-run
equilibrium price and output of agricultural crops in the State? What effect would the
subsidy have on the number of farms producing agricultural commodities in the
State? What would happen to pesticide pollution levels in the State?
(3) Suppose that in addition to the subsidy program, a tax equal to marginal social
damages from pesticides, α, is levied on the farms by the State Environmental
Regulatory Agency. (In this case, the subsidy program is designed with a goal of
being revenue-neutral from the standpoint of the State government). What will be the
impact of the combined subsidy/tax program on the production level of crops for a
typical farm and overall pollution levels from the industry?
(4) Many economists argue that the root cause of subsidies is “rent-seeking” behavior on
the part of firms. Explain the concept of “rent-seeking” in the context of subsidies
that affect the environment. Describe one clear-cut example of rent-seeking behavior
that results in a subsidy that adversely affects environment quality.
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