Solutions Midterm No. 2
EEP1/ECON3
Fall 2003
Professor Peter Berck
Ruth Uwaifo, TA
Emma Aisbett, TA
Question 1 Choose A or B (5points)
A. The following questions refer to the article “Conservation Reconsidered” by John
Krutilla (1967) American Economic Review.
(a) Krutilla argues against a recommendation based on economic theory with regard to
national parks. What was the recommendation that Krutilla was arguing against?
(b) List one of the reasons that Krutilla gives for the public value of a national park being
greater than the potential revenue that could be collected from park entry fees.
(c) List one reason (your own or Krutilla's) why we might expect the value of national
parks to increase faster than the value of manufactured goods in the future.
In general the answers to these questions come directly from Emma's summary that is
available on the web page. This question was easy marks, so waffle did not score well.
You had to know and understand the arguments, and answer the question that was asked.
Some additional notes follow below.
(a) Krutilla was arguing against the suggestion that the government need not have
national parks. The suggestion was that private owners would make the optimal decision
about whether to preserve or develop a potential park.
He was NOT arguing against the suggestion that all parks be developed for resource
extraction.
He was NOT arguing that general open space should be determined by the Government
and not the market. His argument specifically applied to 'one-off', irreplaceable features.
(b) There were a number of reasons, they can be found in Emma's summary. Note that
valid reasons that were NOT given by Krutilla did not receive any marks.
(c) In this question you could give your own valid explanation, or one of Krutilla's. The
main thing that people lost marks for was that they gave reasons that might explain
CURRENT value of parks, but not why this value would be expected to RISE FASTER
than manufactured goods' value in the FUTURE.
OR
B. Based upon your reading of Field and Field, write a short (2 page at most) essay
discussing this statement: “Pollution control policy draws upon command and control
(quotas), market based instruments (taxes or marketable permits), and other strategies to
lower emissions.” An excellent essay gives examples of at least three different types of
strategies and discusses why that strategy might have been chosen for that particular
pollutant.
Question 2 (5 points)
(a)Give two examples of a situation in which there is a dead weight loss.
Here are four examples
1)Quota
2)Tax
3)Externalities like pollution
4)Two firms not allowed to trade in pollution permits
(b)Illustrate ONE of your examples from part (a) with a diagram. Be sure to label all
lines and relevant points on your diagram.
I would illustrate using a tax and an externality
The case of a TAX
P
dd
s
Pc
b
Pp
a
c
s
Q*
Q
Triangle abc is the dead weight loss
The case of an externality like pollution
mc
d
mcs
f
mcp
e
g
qproduced
Q
Triangle efg is the dead weight loss in this case of a negative externality like
pollution
Question 3 (5 points)
“In the short run, a firm maximizes profits by choosing output (Q*) such that the
marginal cost at (Q*) equals the price received.”
For the above statement to be true, which of the following must also be true. Explain
why. A sentence or two should be sufficient.
i.The firm is a price-taker (competitive).(1 point)
This statement must be true as if the firm was not a price taker it would equate it
marginal cost with marginal revenue and not price
ii.AVC(Q*)  P (0.5 point)
This must be true because if AVC>P the profit maximizing output (level of
production) is not Q* such that P=MC(Q*) but 0
iii.AC(Q*)  P (0.5 point)
This statement does not need to be true. In the short run, it is possible that AC>P
but one can still be maximizing at P=MC once AVC  P.
iv.Marginal cost is increasing. (1 point)
It must also be true that MC is increasing. Imagine that MC is decreasing then you do
not want to produce where mc=p as you gain form increasing production to the
minimum mc which does not have to be equal to the price. v. Minimum AVC 
MC(Q*) (1 point)
This statement must be true because for any MC  minimum AVC a firm would
maximize profit where P=that MC greater than minimum AVC but if the mc is less
than minimum AVC the firm would maximize profit at 0. (This is identical to the
condition in (ii).
“In the long run, a firm maximizes profits by choosing output (Q*) such that the marginal
cost at (Q*) equals the price received.”
For the above statement to be true, which of the following must also be true. Explain
why. A sentence or two should be sufficient.
vi. AVC(Q*)  P. (0.5 point)
This condition must be true because in the long run, the firm maximizes profits
according to the above statement only if AC(Q*)<=P. Since ACV(Q)<AC(Q) always,
we have AVC(Q*)<AC(Q*)<=P.
Also if one had said it was false because we do not have an AVC in the long run or
because a firm would shut down or not produce were P=MC in the long run at any
p below AC , full credit was given
vii. AC(Q*)  P (0.5 points)
As explained above, this condition must be true because unlike the short run when you
can stay in business even if P<AC and produce where P=MC ,in the long run you
only stay in business and produce where P=MC where P  AC.
Question 4 (5 points)
A firm produces an output using two inputs as shown on the attached isoquant diagram.
Without government intervention, the firm operates at point A on the diagram. The price
of labor is one.
These results are estimates based on accurately drawing your line tangent. Any
answer within a reasonable range gets full credit any answer significantly off got
partial credit. If you do not understand how these results are derived please see
Ruth or Emma.
(a) (1 point) What is the price of water? The price of water is $1(13/11 or any price
that is approximately 1 is acceptable)
(b) (0.5 point) What is the cost of producing this output? The cost is $12
Water use decimates wildlife habitat and the government wants to limit its use.
The limitation results in the point B being chosen.
(c)(1 point) If point B was chosen in response to a tax on water, what would be the after
tax price of water? The price would be $2.25 ($2 dollars or any thing 0.5 less or more
than two was given full marks)
(d) (1 point) What would be the cost of production? The cost would be $18 ($17 or any
cost 1 less or more than 18 was acceptable
(e)(1.5 points) If point B was chosen in response to a Technology Based Effluent
Standard, what would be the price of water and what would be the cost? The price of
water would be still be at $1 but the cost would be $13 ( Any answer given that was
approximately one or $13 was also given credit)
Labor
Isoquants
20
19
18
17
16
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
Q=6
A
B
expenditure
expen2
TBES
0
1
2
3
4
5
6
7
8
9
10
Water
11
12
13
14
15
16
17
18
19