Final Exam - check your answers

The answer is yes, as long as the common property problem has been solved.  The explanation would focus on the Hotelling Theorem: that efficiency requires MSS to rise at the interest rate, that oil owners will trade until the royalty rises at the interest rate, and that since MSS and the royalty are equal, the market equilibrium will be efficient.

(a) Q1 = 25, Q2 = 50, Q3 = 75.

(b) The tax should be $250. The abatement costs of the three firms are: $3,125, $6,250 and $18,750 (note that source 3's abatement costs are a rectangle, not a triangle). Their tax payments are: $18,750, $12,500 and $6,250, and their total compliance costs are: $21,875, $18,750 and $25,000. Command and control regulation would usually mean spending more on abatement but the firms would see lower costs overall because it would avoid the transfers of a tax system.

(c) Dividing abatement costs by 3 gives $9,375 per firm. Firms 1 should pay $6,250 more, firm 2 should pay $3,125 more and firm 3 should pay $9,375 less. Since the permits will trade for $250, the initial distribution that will achieve this is: 50 permits to firm 1, 37.5 permits to firm 2, and 62.5 permits to firm 3.

(a) 600.

(b) From algebra and the results of (a),  A = 5 and B = 0.005. The annual value is the area of the CS triangle when P=0: $2,500. 

(c) Understate: since only visitors are counted, it leaves out existence value and option demand.  To measure those, a contingent valuation study could be done to complement the travel cost calculation. The answer should then discuss some of the potential weaknesses of CV and how they might be addressed.

(a) Q1 = 5, Q2 = 5; P1 = 80, P2 = 130; MSS1 = R1 = 50, MSS2 = R2 = 100.

(b) P2 falls to $90 and R2 falls to $60.  Because of the price drop, Q2 rises to 15.  R1 falls to $30 and P1 to $60, causing Q1 to rise to 10.  The backstop lowers the prices and royalties in both periods, and increases the amount consumed in each period.  As it happens, all of the original resource is consumed in the first period (Q1 = 10) and the second period uses only the backstop.