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1. Final. EEP1/Econ 3 2014. Berck, Lu, Sutula. (6 pts--1 pt each) Explain why each statement is true, false or uncertain. a. b. c. d. e. f. Competitive firms choose price so that price equals average cost. When price is below the minimum point of average variable cost a firm should chose positive production and there will be negative profits. A tax on emissions of polluting firms has no effect on the long run equilibrium price and quantity. The input bundle a firm chooses can be found from where its budget constraint hits the y-axis. Public goods are underproduced. When income goes up, the market equilibrium quantity of every normal good must increase. 2. (6pts) Draw and explain a consumer choice diagram with the following facts. The budget constraint has vertical (or y) intercept 1 and horizontal (or x ) intercept 8. The chosen bundle includes 6 units of good 1 (on the horizontal axis). a. What is the ratio of P1to P2? b. What is the chosen bundle? c. (2pts) Making reference to your diagram, why was that bundle chosen? d. On a fresh copy of your diagram show what happens when the price of the first good doubles. e. Assuming that P2 =1, add a line and use it to show what the compensating variation is for the price doubling. 3. (8pts)The demand for t-shirts is Q = 20 – P/2, where Q is the number of t-shirts and P is their price. The private cost of producing t-shirts is C(Q) = Q2, with private marginal cost MCP = 2Q. Washing and dyeing the t-shirts causes water pollution with total damages CE(Q) = Q2/2, and marginal external costs of MCE = Q. a. (1pt)What is the private supply curve for t-shirts? Use that private supply curve plus the demand curve to find the equilibrium price and quantity. What is the price? The quantity? This is the market solution. b. (1pt)What would the price and quantity be if the pollution externality were accounted for by the firm. This is the efficient solution. c. (1pt)What are the net benefits for each of the efficient and market solutions. d. (2pts)What is the equation showing the marginal benefits of polluting as a function of the number of shirts produced.? Use this formula to show how many shirts will be produced if the shirt producer can ignore external costs. Explain how to use this formula and other information to find the efficient quantity. What is the efficient quantity? e. (3 pts) Let abatement be any reduction in production from the private-market equilibrium. First, provide a formula for abatement based on that description. Now provide formulas for the marginal cost of abatement and the marginal benefits of abatement. Use these to find the efficient outcome. 4. (6pts) The Clean Air Act and the Clean Water Act both seek to clean the environment. However, they have slightly different roles for the states relative to the federal government. Give a brief account of how these laws work. (Hint: think New Source Standards, TBES, State Implementation plan, Acid Rain, NPDES, NAAQS, TDML). How are they fundamentally different? 5. (8 pts, two for each) Consider a farm regulated with an effluent standard for leachate. The attached figure shows an isoquant and two isopleths (equal pollution curves). Show your work on the attached figure as well as writing an explanation in your blue book. a. b. Label the curves on the diagram and explain why a tangency between a price line and an isoquant is important. What are the prices on the price line that makes the unregulated input bundle the cost minimizing bundle? Assume the price of water is one. (You may leave your answer as a fraction and/or round off numbers to the nearest 10. Note that the diagram does not go all the way down to zero!) c. d. (6pts) Regulation leads to higher costs. Draw a picture with two average cost curves, one higher than the other, and such other curves as you may need to answer the following: a. (2) What would make one of the average cost costs lie above the other? Give a concrete example of such a regulation and how it would have this effect. b. (2) What is the long run supply curve associated with each average cost curve. c. (2) What is the market quantity and price in each case. 860 840 Water (mm/hectare) 6. What is the cost to the grower of an emissions standard that forces the grower onto the lower isopleths at bundle D? What would be the costs to the grower if water were taxed in such a way as to make him choose bundle D? 820 A 800 Original Pollution 780 D Lower Pollution 760 740 120 130 140 150 160 170 180 Nitrogen (kg/hectare) 190 200 210 220