Peter J. Wilcoxen

Department of Economics

University of Texas at Austin

*Spring 1998*

**Section 1 (4 parts, 28 points total)**

- People who are not economists often take it for granted that oil and other exhaustible resources are being
used up much too quickly because people alive today do not take future generations into account. Is this true?
Discuss in detail.

- Congress is currently debating reauthorization of the Endangered Species Act. As the Act now stands, any species
considered endangered must be protected without considering the costs and benefits of doing so. Some people have
suggested that the Act should be changed to take costs and benefits into account. If that happened, what method
or methods would be appropriate for measuring the benefits of preserving endangered species? Why? What are the
strengths and weaknesses of the approach(s) you propose?

- Global warming is a difficult problem because both the costs and benefits of reducing it are largely unknown.
One thing that seems fairly clear, however, is that the severity of the problem rises smoothly with the amount
of carbon dioxide in the atmosphere and does
*not*increase sharply at a particular threshold. Discuss what sort of policy, if any, would be best for controlling carbon dioxide. Be sure to explain your position in detail.

- Suppose that the US Geological Survey has collected the information below about
*discovered*deposits of a resource. It is also known that only 20% of the area where this resource might be found has been explored. The price of the resource is currently $25.

Grade of ore |
A |
B |
C |
D |
E |
F |

MEC ($) |
10 |
20 |
30 |
40 |
50 |
60 |

Quantity (tons) |
100 |
200 |
300 |
500 |
700 |
900 |

Given this information, please calculate what the USGS would report as (1) proven reserves, (2) identified subeconomic reserves, (3) undiscovered economic reserves, and (4) undiscovered subeconomic reserves. (In other words, construct the four-cell USGS table for this data.) Be sure to explain how you calculated your numbers. Using this data, give examples of three specific events that would increase proven reserves by 100%.

**Section 2 (2 parts, 14 points total)**

Suppose an exhaustible resource is to be allocated across three periods. The resource is subject to increasing marginal extraction costs and demand is increasing over time. In particular, suppose that the following is true:

Demand in period 1: P1 = 100 - Q1

Demand in period 2: P2 = 200 - Q2

Demand in period 3: P3 = 300 - Q3

Marginal extraction costs: MEC = QT/3

where QT is the total amount of the resource extracted to date. Throughout this problem you may assume the interest rate is zero.

- Find the efficient allocation of the resource across the three periods. What will the price, quantity, marginal
extraction cost and royalty be in each period? Be sure to show all your work.

- Now suppose that a backstop resource is available at a marginal cost of $50. Calculate how the backstop would change the efficient use of the resource. Be sure to show what happens to prices, extraction costs, royalties and production in each period. In what period does the backstop begin to be used? Why? You should assume that everyone knows about the backstop at the beginning of period 1.

**Section 3 (2 parts, 14 points)**

One important motivation for recycling bottles and cans is to reduce litter. Suppose you are given the following facts about the glass bottle industry:

The demand for tons of bottles is given by Q = 1000 - 10*P.

The cost of producing bottles from raw materials is $50 per ton.

Litter creates an externality cost of $20 per ton of bottles produced.

Bottles can be recycled at a MC of $1*X, where X is the tons recycled.

Please answer the following questions:

- Find the market outcome when firms take prices as given and the industry ignores the litter problem. Find the
price, the total quantity of bottles consumed, the amount produced from raw materials, and the amount produced
by recycling (if any).

- Explain why the outcome in part (1) is not efficient. Use an appropriate graph to illustrate your explanation. Now calculate the efficient outcome and suggest a specific policy that could move the industry toward efficiency.