### Economics 359M

Peter J. Wilcoxen
Department of Economics
University of Texas at Austin

### Exam 1

Fall 1991

#### Section 1: Short Answer (4 parts, 20 points total)

Defend or refute each of the following assertions. Explain your position as completely as possible. If you use graphs, be sure to explain what each one is intended to show.
1. The United States has a proven reserve of 27 billion barrels of of oil. Annual consumption is around 3 billion barrels, so if all oil imports were cut off the nation would run out of oil in 9 years.

2. Common property resources are usually overused.

3. People drive too much in Los Angeles.

4. Exploration possibilities and backstop technologies have a similar effect on the use of an exhaustible resource.

#### Section 2: Essay (2 parts, 30 points total)

Answer each of the following questions. Use graphs or models wherever it would help support your argument.
1. Explain in nontechnical terms what economists mean by inefficiency (in a static context). Next, explain what externalities are and how they lead to inefficiency. Illustrate your answer with examples for both positive and negative externalities.

2. Under a perfect system of property rights, a social planner and a competitive market would allocate an exhaustible resource in the same way. Why? Explain as completely as you can.

#### Section 3: Problem (5 parts, 25 points total)

For some resources at certain stages of exploitation, marginal extraction costs might FALL as more of the resource is used. This could occur if firms in the industry were actively learning how to extract the resource. In this case, a social planner might want to SUBSIDIZE use of the resource in early years. This problem asks you to explore that issue. Suppose you are given the facts given below:
• There are two periods, 1 and 2
• Demand in 1: P1 = 100 - 12 Q1 (P1 and Q1 are P and Q in period 1)
• Demand in 2: P2 = 100 - 12 Q2
• MEC in 1: MEC1 = 60 - 2 Q1 (MEC1 is MEC in period 1)
• MEC in 2: MEC2 = 60 - 2 ( Q1 + Q2 )
• The interest rate is 0