EnvEcon 1 / Econ 3
Quiz 2
P. Berck
Fall 2006
Answer all four of the following questions in your blue book. Each of the four questions is worth
five points for a total of 20 points.
1. Define
A New Source Performance Standards
New Source Performance Standards regulate the level of pollution that a new stationary
source may produce. They are often set by the US-Environmental Protection Agency
B Tradable pollution permits
Tradable pollution permits: A regulator sets a limit on the total level of pollution that can
occur. Firms that emit the pollutant are given credits for the right to emit a specific amount.
Total credits cannot exceed the cap. Firms that pollute beyond their allowance must buy
more credits from firms that emit less than their allowance.
C
Marginal cost
Marginal cost is the cost of making the next unit. MC (q) is approximately C(q+1) - C(q).
D Economic profit
Economic profits (Π=PQ-C(Q)) is the difference between total revenue and total costs This
total costs include all opportunity costs of production. Another definition is economic profit
equals business profit minus the opportunity cost of capital and any other input supplied by
the firm owners.
E
Long run competitive equilibrium
Long-run competitive equilibrium: At this point, every firm produced at the minimum point
on its average cost curves. Thus the output of competitive firms is produced at lowest cost to
the society. P=MC=AC
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2. Assume a company has the following cost structure.
Please first fill the table. (3pt)
Quantity
Total
Cost
Total
Variable
Cost
Average
Total
Cost
Average
Variable
Cost
Marginal
Cost
0
1
2
3
4
5
10
15
18
22
34
48
0
5
8
12
24
38
---15
9
7.33
8.5
9.6
---5
4
4
6
7.6
5
3
4
12
14
NA
(1pt) If market price is 3, how many products will the company produce?
If market price is 3, since 3<AVC, the company will shutdown.
(1 pt) If market price is 14, how many products will the company produce?
If p=MC=14, then the output would be 4 units.
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3. A mill uses air and other inputs to produce paper. Assume that the price of other stuff is $1. The
price of air is $2.50.
(A) (1 pt) Draw an isocost line that represents $50 in expenditure.
60
Other Stuff
50
40
30
20
10
0
0
20
40
60
Air
(B) (2pt) The mill hires a new manager and sets a production goal, described by the isoquant in the
figure above. What is the least cost input bundle that can achieve this goal? What is the total cost
associated with this level of production?
Parallel Shift the isocost curve to tangent with isoquant curve, we get the least cost input bundle is
approximately (20,25) . The total cost associated with this level of production is 20x2.5+25x1=75
(C) (2pt) If the mill does not change its production goal, what would the price of air need to be for 30
units of air to be a cost-minimizing choice? (Use the graph and explain clearly how you got your
answer.)
Draw a line that is tangent with the isoquant curve and passes through the point (30,15). The line will
intersect the x-axis at approximately 60 and intersect the y-axis at 30. Because the price of other stuff is
1, the price of air must be 0.5.
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4. Use a graph and words to explain deadweight loss. Follow the step outlined below.
(A) Draw a supply and demand diagram for a firm and mark the equilibrium.
P
S
D
Q
(B) (2pts) Assume that the firm's output is polluting and every unit of output leads to damage in amount
$t. Use this fact to add a curve to your diagram and explain what the firm’s output ought to be.
Social
Cost
P
S (MC)
D
Q
Q0
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(C) What would be the deadweight loss if the firm produced as in (A) instead?
Social
Cost
P
S (MC)
b
D
a
c
Q
Q0
On the graph the triangular “abc” represents the dead weight loss.
(D) Explain exactly what this deadweight loss is.
A deadweight loss reflects a loss of economic efficiency. To the left of point “a”, willingness to pay is
higher than social cost. When produce at Q0, we get the highest social welfare. To the right to point of
“a”, since the social cost is higher than willingness to pay, the social welfare is decreasing. The firm
will make a production decision based on the intersection of the demand curve and its private marginal
cost curve. At the production level, from the graph, we can see the triangular “abc” that represents
deadweight loss.
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