EWU – ECON 457 - Natural Resource Economics
Take-Home test 1
Student name: ___________________________________________________________
Part I. Discussion Questions (18 points).
Question #1. (6 points) Explain the following key points about benefit-cost analysis and efficiency:
- Explain the concepts of static efficiency and dynamic efficiency and how they relate to benefit-cost
analysis.
- Explain why and under what conditions a competitive market would lead to an efficient allocation of
resources.
- Explain why the following statement is inaccurate: “Pollution destroys natural environments and
human health; it should be reduced to zero.”
Question #2. (6 points) Explain the following key points about public goods:
- Explain the concepts of non-rival good and non-exclusive good; give an example of a non-rival
good, and an example of a nonexclusive good -- justify your choices of examples.
- Explain the difference between determining an efficient provision of a public good and an efficient
provision of a private good.
- Explain the free rider problem: give me the intuition of the problem by describing a situation where
this problem might occur. In light of this problem, will voluntary (private) provision outcomes most
likely be efficient?
Question #3. (6 points) Explain the following key points about externalities:
- Explain the concept of negative externalities; give an example a negative externality -- justify your
choice of example.
- Explain what level of provision of goods and services (or what level of resources use) is reached in
the presence of negative externalities, in comparison to what would be the efficient level of
provision of goods and services (or use of resources).
- Explain how bargaining or/and well defined property rights could lead to a correction of the
externalities and an efficient provision of goods and services (or use of the resources).
Part II. Problems (22 points).
Problem 1. (4 points)
Suppose you are considering buying a gold deposit. It will cost $1 million per year to construct a mine so that
gold can be extracted. The construction period lasts 3 years. In the fourth year, production starts. Each year the
mine operates, it will yield net benefits of $500,000. What will you pay for the gold deposit if:
(a) (2 points) Interest rates are 5 percent and gold can be extracted for 6 years?
(b) (2 points) Interest rates are 3 percent and gold can be extracted for 6 years?
For each case above turned in a copy of your Excel worksheet. Indicate formulas you may have used in
different cells.
Problem 2. (10 points)
Dougwood city has a terrible problem of pollution (dust and smoke) from the concrete plant located just south
of town.
The marginal private costs (MPC) of operating the plant are: MPC = 2 + (1/250) Q, where Q = tons of concrete
per day. The marginal damage (MD, health and property damages) is estimated at a constant $2 per ton of
concrete produced.
The plant sells its concrete in a perfectly competitive market. It takes the market price of concrete as given: $10
per ton. This is its marginal private benefit (MPB), which is also equal to the marginal social benefit (MSB).
(a) (3 points) Plot the MPC, the MSB and the MSC curves. Label your curves.
(b) (2 points) Find the optimal private output of concrete (the output chosen by the plant) through
calculation. Identify that output in your diagram as QP.
(c) (2 points) Find the efficient output of concrete (the output chosen by society) through calculation.
Identify that output in your diagram as QE.
(d) (1 point) Calculate the loss to the concrete plant if it were forced to produce the efficient level of
concrete. Indicate this loss on your diagram.
(e) (1 point) Calculate the gain to society if the concrete plant were forced to produce at the efficient level
of concrete. Indicate this gain on your diagram.
(f) (1 point) Calculate the net gain to society if the concrete plant were forced to produce at the efficient
level of concrete (use the results you got in part (d) and (f)). Indicate this net gain to society on your
graph.
Problem 3. (8 points)
Consider the relationship between level of effort (number of fishers) and total catch (measured in dollars, price
held constant) in an open-access fishery, as given in the table 1 below.
Table 1. Relationship between effort (number of fishers) and total catch (measured in $, price held constant)
Level of Effort
(# of fishers)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Total
Catch
0
70
150
240
320
390
450
500
540
570
590
600
600
590
570
540
1. (2 points) Use Excel to plot the Total Revenue and Total Cost curves, assuming a constant level of effort
of $50.
2. (2 points) Using Excel compute the Marginal Revenue and Average Revenue. Plot the Marginal
Revenue, the Average Revenue and the Marginal Cost on a second graph. Turn in both table and graph.
3. (1 point) Determine the efficient level of effort. Illustrate this point as E* on both graphs.
4. (1 point) Determine the most likely outcome of the open-access fishery. Illustrate this point as E0 on
both graphs.
5. (2 points) Explain how the above open-access fishery outcome would come about.