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Final. EEP1/Econ 3 2014. Berck, Lu, Sutula.
(6 pts--1 pt each) Explain why each statement is true, false or uncertain.
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.
(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
(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 =
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
(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?
(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.
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!)
(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.
Water (mm/hectare)
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?
Original Pollution
Lower Pollution
Nitrogen (kg/hectare)