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: Please answer the following questions:
  1. Graph the equilibria in periods 1 and 2 if period 1 ignores period 2 when making its decision on how much to consume. Find the equilibrium price and quantity in each period.

  2. Explain why the equilibrium in (1) is not what a social planner would choose. Use the graph from part (1) if it will help to illustrate your point.

  3. The horizontal sum of the demand curves for the two periods is given by P = 100 - 6 ( Q1 + Q2 ). Using this information, find the total usage of the resource (that is, Q1 + Q2 ) that the planner would prefer. What price is associated with this quantity?

  4. Based on the results you obtained in part (3), what price would the planner charge in each period? What quantity of the resource would be extracted in each? Explain any differences between these results and those of part (1).

  5. Calculate the subsidy that would be required to achieve the equilibrium in part (4). Explain.