Spring 2014 Exam 1 Solution

Here are the final numerical results for each section of the exam.  You can use them to check your work if you do the exam for practice.  If you have trouble with the problems, or don't get the answers shown here, stop by during office hours or make and appointment and we can go over them.

Question 1

(a) Market: P=$100, Q=800; efficient output=558.

(b) Tax=$139.  Although the problem did not ask about prices, Pd=$209 and Ps=$70.

(c) Gain in externality=$41,139; overall welfare gain=$24,242.

(d) Quantities consumed by H and L households=17.6 and 19.1. Revenue from an H household=$2450; revenue from an L household=$2661; revenue as a percent of income=2.4% and 6.7%.

(e) Net effect on an L household=$604; percent of income=1.5%; policy is progressive.

Question 2

(a) NPVs: gray=$4M; green under H=$10.2M; green under M=$600k.

(b) Expected NPV of green=$5.4M. A risk-neutral agent would use green infrastructure.

(c) EU of each option using NPVs in millions: gray=45, green=42.  A risk averse agent would pick gray infrastructure.  CE of green=$3.2M.  Decision is NOT efficient: EV of green is higher.

(d) Assuming that the grant would only cover the green option (no need for a grant for the gray option), yes, it would change the city's decision to green.  The city's construction cost for green would go down to $6.3M, its EU would rise to 47 and its CE would rise to $4.7M.

Question 3

(a) NPVs: E=$2.4M; T=$3.68M; N=$0. Tight regulation is best.

(b) NPV=$4.2M.

(c) Waiting and then regulating is best.  It preserves the regulator's option to use the more lenient regulation E if the aquifer turns out to have low vulnerability.  However, it does involve a significant cost because no revenue is earned during years 1-3.  Overall, the option value (including the cost of waiting) is $527k.