Environmental Economics Homework 1

The following data applies to questions 1 and 2:

a. All individuals in society are the same.

b. Individual demand for good X is given by P=20-2Q.

c. There are 3 individuals.

d. Marginal cost of producing good X is MC=2Q+4.

Q1. Suppose Good X is a public good.

a. State an equation of the aggregate demand for the good, i.e. P=...? Show your work.

b. Draw a graph of aggregate demand, indicating the values of the vertical and horizontal intercepts (that is, the value of P at which Q=0, and the value of Q at which P=0). It should be clear to you that this demand is the vertical summation of individual demands.

c. Draw the marginal cost curve on the graph and label it "MC".

d. What is the efficient production of the good?

e. According to economic theory, will a market generate the efficient amount of the public good? Explain in 2 sentences or less.

Q2. Now suppose Good X in Q1 is a private good.

a. State an equation of the aggregate demand for the good. Show your work.

b. Draw a graph of aggregate demand, indicating the values of the vertical and horizontal intercepts (that is, the value of P at which Q=0, and the value of Q at which P=0). It should be clear to you that this demand is the horizontal summation of individual demands.

c. Draw the marginal cost curve on the graph. What will be the market equilibrium price and output (actual numbers please)?

d. How much of the good will be consumed by each individual? (Use your individual demand equation to confirm this).

Q3. The owner of a pulp mill polluting a scenic river argues at a public hearing: "These environmentalists should quit whining. I offered to cut pollutants if I was compensated for it. So far not one of these so-called "environmentalists" has taken me up on my offer. If the benefits of preserving this river were so great, someone would have paid me by now to stop polluting." What about this argument --does it stand up to economic scrutiny?

a. Yes. Economics tells us that if an individual has a positive willingness to pay for a good, then they will in fact make the payment if given the opportunity.

b. Yes. Adam Smith's "The Wealth of Nations" makes clear that if at the margin the value of a good to consumers is greater than its cost of production, the "Invisible Hand" of the market will assure that more of the good is produced. In the current context, this means that if environmentalists truly do value reduced pollution, then they would pay the mill owner to reduce his firm's pollution (that is, pay him to "produce more pollution reduction").

c. No. Even though environmentalists may place a high value on reducing pollution collectively, paying the mill owner is not privately rational -the cost of reducing emissions to the extent that it has a noticeable effect exceeds the payment that can be borne by any one individual.

d. No. Environmental improvements are not market goods, so it's not possible to put a dollar value on them.

e. No. Improving the river amounts to the provision of more of a public good.

f. No. The benefits of such an improvement are nonrival and nonexcludable.