### Economics 359M

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

### Exam 2

Fall 1993

#### Section I, Short essay (3 parts, 21 points total)

Answer each of the following questions as completely as possible in the time allowed.

1. Explain as specifically as you can what goes wrong in open access fisheries. Discuss several policies that could be used to solve this problem.

2. When markets fail to produce an efficient outcome for an environmental or natural resource problem, the government may have to intervene. Explain why market based policies have a major economic advantage over command and control regulation. Illustrate your explanation with examples from fishery management and pollution control.

3. Discuss the relationship between environmental amenities, irreversibility, and technical change. How should this affect environmental policy?

#### Section II, Problem (4 parts, 28 points total)

Suppose a river is used by two groups of people: farmers and rafters. The farmers want to divert water for offstream use and have a demand curve given by Pf = 2200 - 20Qf (where Pf and Qf are the willingness to pay and quantity of water to farmers). The marginal cost of diverting a unit of water is 200 but this is subsidized by the government and the farmers pay nothing. The rafters want to have water in the stream and their use is nonrival. There are 10 rafters altogether and each one has a willingness to pay for water given by Pr = 200 - Qr (where Pr and Qr are the willingness to pay and quantity of water to rafters). The marginal cost of using water for rafting is zero. The total amount of water in the stream is 240.

1. Show that under present US water law, the equilibrium amount of water diverted to farmers will be 110 units. Explain what features of water law lead to this outcome. Is this likely to be efficient? Why or why not?

2. Show that the marginal social surplus of water used by farmers is given by MSSf = 2000 - 20Qf and that the marginal social surplus of water used by rafters is MSSr = 2000 - 10Qr. Explain how you found each of these expressions.

3. Show that the efficient allocation of water is 80 units to farming and 160 units to rafting. Briefly explain why this is efficient. How would the government have to change the subsidy in order to reach this outcome?

4. Draw a graph or graphs to illustrate the difference in efficiency between the outcomes in part (1) and (3). Show that the inefficient case results in a loss of \$13,500 of potential social welfare.