Fall 2007
Econ 344
1st Midterm
60 minute test worth 100 points
I. Multiple Choice (3 pts. each * 9 = 27)
1.
The First Fundamental Theorem of Welfare Economics requires
a)
producers and consumers to be price takers.
b)
that there be a market for every commodity.
c)
that the economy operate at some point on the utility possibility curve.
d)
all of the above.
2.
Which method helps in obtaining the socially optimal level of output?
a)
Pigouvian taxes
b)
regulation
c)
property rights and bargaining
d)
all of the above
3.
Summing demand curves horizontally sends market ______________ to
individuals, while summing vertically sends market ______________ to
individuals.
a)
price; price
b)
quantity; quantity
c)
quantity; price
d)
price; quantity
4.
Suppose your roommate smokes in your apartment, imposing a cost on you. The
Coasian Theorem suggests that one solution would involve
a)
the government establishing that your roommate owns the air in your
apartment.
b)
the government establishing that you own the air in your apartment.
c)
the government establishing that it owns the air in your apartment.
d)
either a, b, or c.
e)
either a or b.
5.
In a public goods context, it is difficult to measure the impact of public goods on
real income because
a)
public goods are generally free to the public.
b)
they make up a small percentage of total GDP.
c)
people do not reveal how they value public goods.
d)
inflation decreases the value of the good.
6.
Lindahl prices
a)
result in efficient levels of public goods provision.
b)
require honest revelation of preferences.
c)
result in different prices for the same amount of output.
d)
cause all of the above.
e)
cause none of the above.
7.
Which of the following statements is correct about cost-benefit analysis?
a)
A higher discount rate should be used for riskier projects in social cost-benefit
analysis.
b)
In social cost-benefit analysis, unadjusted market prices should be used
whenever market prices are available.
c)
Consumer surplus is the excess of consumers’ total willingness to pay for a
given quantity of a good over the amount that they actually do pay.
d)
A higher discount rate favors projects that yield net benefits in the future.
8.
Suppose you have 3 years to live and you value each year of life at $7 million but
have a discount rate of 5%. How much do you value the rest of your life in today's
dollars?
a)
$20 million
b)
$19.06 million
c)
$21 million
d)
$18.14 million
e)
none of the above
9.
To maximize social welfare, which of the following must always be true?
a)
Marginal social benefit equals marginal social cost.
b)
Marginal private benefit equals marginal social cost.
c)
Marginal social benefit equals marginal private cost.
d)
Marginal private benefit equals marginal private cost.
e)
Both a and d
II. Definitions, Short Essay, and Problems
1. ( 3 pts each) Explain 3 of the following 4 terms and give an example of each:
Externality
Free rider
Log-rolling
Coase theorem
2. (18 pts) Andrew, Beth, and Cathy live in Durant. Andrew’s demand for bike paths, a
public good, is given by Qa= 12 – 2P. Beth’s demand is Qb= 18-P and Cathy is Qc= 8P/3 where Q= miles of bike paths. The marginal cost of building the bike path is $21, a
constant.
a. What is the socially optimum number of miles of bike paths?
Bike paths are a public good. The 3 WTPs need to be summed
Andrew: 2P+ 12- Qa ; Pa = 6- .5Qa
Beth:
Pb = 18 – Qb
Cathy:
P/3 = 8 –Qc; Pc = 24-3Qc
Aggregate Willingness to Pay : Pa + Pb +Pc = MC  6-.5Q+18-Q+24-3Q 
48-4.5Q=21 27=4.5Q
Q=6
b. Given these demand preferences, if the city uses a Lindahl taxing scheme, what would
be the tax bill for each individual?
A: P = 6 - .5 (Q) 6 - .5(6); Pa = 3
B: P = 18 – (6); Pb = 12
C P= 24- 3(Q) = 24- 18 =6
A=3/21 B= 12/21 C = 6/21
c. If the city had taken a more egalitarian approach and taxed each individual equally (i.e.
$7 each) to finance the bike path, would any of the bikers have a consumer surplus (MB>
their tax share of $7)? Which one(s)?
Yes, Beth
3.(10 pts) Dakota has two regions where they have different preferences for pollution
cleanup. In Nordland, the marginal benefit associated with pollution cleanup is MB = 300
– 10Q, while in Southland, the marginal benefit associated with pollution cleanup is
MB = 200 – 4Q. Suppose that the marginal cost of cleanup is constant at $12.
a. What is the optimal level of pollution cleanup in each of the two regions?
Pollution averted is a benefit;
Optimal clean up is where MB = MC
North: 300-10Q = 12; 288 = 10Q
Q = 28.8
South: 200-4Q =12; 188=4Q Q= 47
b. If the government decides to mandate that Dakota needs to clean up 60 units of
pollution, is each region of Dakota likely to clean up an equal number of units?
Can you suggest a more cost effective scheme than requiring each region to clean up 30
units? (no math required)
No,
Southland is more efficient , could accept payment from Nordland to do more pollution
reduction
4. (20 pts) The private marginal benefit of producing cured ham is 15- X where x is
number of units consumed. The private marginal cost of producing X is 3 + X. For each
unit of cured ham (X) produced, there is an external cost imposed on society of $2 per
unit (2X).
a. In the absence of any government intervention, how much cured ham ( X) is produced
(the private market solution)?
Private solution : PMB = PMC
15-X = 3+X; 12 = 2X X=6
b. What is the social efficient level of production of cured ham?
Social Solution: MSB = MSC
15-X = 3+X + (2X); 12 = 4X; X=3
c. What is the gain to society in moving from the inefficient to the efficient level of
production?
Dead weight loss triangle: .5(base * height)  .5 (3*6) = $9
d. Suggest a Pigouvian tax that would lead to the efficient level of production.
$6
e. How much revenue would be raised with this tax?
$6 * 3 units = $18
5. (16 pts) The Corps of Engineers is planning to improve navigation on the Missouri
River by building locks and dredging. Only the first 3 years of the project are relevant.
Construction costs are estimated at $20 million, all in year 0. Annual dredging costs are
$2 million per year, starting in year 1. Benefits are lower transportation costs of $5
million in year 1, $6 million in year 2, and $7 million in year 3. In years 2 and 3, fishing
and boating benefits are $5 million per year. The social discount rate of 6% is used.
a. What is the Net Present Value(NPV) of the Costs?
$20 + 2/(1.06) + 2/(1.06)^2 +2/(1.06)^3
20 + 1.886 + 1.781 + 1.679 = $25.346
b. What is the Net Present Value(NPV) of the Benefits?
0 + 5/(1.06) + (6+5)/(1.06)^2 + (7+5)/(1.06)^3 =
0 + 4.176 + 9.795 + 10.075 = $24.04
c. What is the Net Present Value (NPV) of the project?
NPVbenefits - NPVcosts
24.04 – 25.346 = -1.306
d. What is the ratio of NPV of benefits to NPV of costs?
24.04/25.346 =.97
e. Should the project be built?
No, it doesn’t meet the positive NPV criterion