ECON 117 Environmental Economics

ECON 117 Environmental Economics

Homework 1 assigned on Jan 30 (Tuesday)

Due: Feb 6 (Tuesday) in class

Instructor: Dr. Qin Fan

Spring, 2018

1. There is a factory that is dumping toxic waste into a river where a resort is located downstream. At the moment the factory is not filtering the water that it dumps into the river.  There is a filter it could install that would remove a significant amount of the toxic elements from the water before it is dumped in the river.  The factory and the resort have each assessed the situation and come up with the following data:

• If the factory is given ownership of the river, what choice will it make? How much would the resort be willing to pay to get the factory to make a different choice?  Will the factory accept? (10 points)

• If the resort is given ownership of the river, what choice will it make? How much would the factory be willing to pay to get the resort to make the other choice?  Will the resort accept? (10 points)

• Assuming negotiation costs are negligible and there are two parties involved in this case. Use Coase Theorem to explain the negotiation outcome. (15 points)

2. Use a simple algebraic example to understand externalities.

• Given demand: P=100-2Q=MB; supply: P=10+0.5Q=MC_p

Solve for the market equilibrium price and market equilibrium quantity and illustrate graphically. (10 points)

• Suppose external cost (EC) from pollution EC=10. Thus the marginal social cost MC_s=MC_p+EC, illustrate this new cost curve on your graph. Solve for the socially optimal (or efficient) price and socially optimal (or efficient) quantity and illustrate graphically. (10 points)

• Which area on the graph represents deadweight loss (DWL)? Calculate the area for DWL. (15 points)

3. Refer to the case as discussed in class. Suppose two firms are located by a river. The first produces steel, while the second, somewhat downstream, operates a resort hotel. The steel firm uses the river as a receptacle for its waste, while the hotel uses it to attract customers seeking water recreation. If the steel plant dumped waste into the river without bearing the cost of reduced business at the resort resulting from polluted water, negative externality arise from the non-price interaction between steel plant and resort hotel.

The diagram below shows socially optimal (efficient) quantity for steel production at Q*.

• If the resort offers a bribe of C+D to make the steel plant reduce steel production from Q_m to Q*, would the steel company be willing to accept the offer and reduce production to the socially optimal level at Q*? Why or why not? (5 points)

• Which area in the diagram represents the minimum amount of the bribe, beyond which the steel company would accept the offer? (5 points)

4. The major oil-exporting countries have formed a cartel, resulting in higher-than-normal prices. A cartel is a collusive agreement among producers to raise prices. This collusive agreement allows the group to act as a monopolist. Read Debate 2.1 titled “How Should OPEC Price Its Oil” in your textbook (page 36) and answer the following questions.

• Draw marginal cost, demand, and marginal revenue curves for monopoly in the same diagram. (5 points)

• In the diagram, indicate the monopoly price, monopoly quantity, efficient price, and efficient quantity. Explain why OPEC could charge higher prices on oil. (5 points)

• Does monopoly or market power cause market failure? Why or why not? (5 points)

• In the diagram, indicate deadweight loss using shaded areas. (5 points)