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Economics 325: Public Economics Sections A01, A02

University of Victoria Midterm Examination #1

VERSION 2

Fall 2014 Instructor: Martin Farnham Section 1: Multiple Choice—Each question is worth 3 points. Select the most appropriate answer, and fill in the matching letter on your bubble form. Assume that, unless otherwise indicated, markets are competitive. Questions 1-5 refer to the following diagram.

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1) Is there an externality present in this market? If so, what kind of externality? A) Yes, it’s a positive consumption externality. B) Yes, it’s a negative consumption externality. C) Yes, it’s a positive production externality. D) Yes, it’s a negative production externality. E) No, there is no externality present. 2) What is deadweight loss at the efficient quantity? A) $2,000 B) $4,000 C) $6,000 D) $8,000 E) None of the above. Remember, DWL is always zero at the efficient quantity. That’s why we aim to achieve efficiency. 3) What are total external benefits at the efficient quantity? A) $2,000 B) $4,000 C) $8,000 D) $16,000 E) None of the above. 4) What are aggregate net benefits at the efficient quantity? A) $4,000 B) $10,000 C) $12,000 D) $16,000 E) None of the above. 5) What are aggregate net benefits at the equilibrium? A) $4,000 B) $10,000 C) $12,000 D) $16,000 E) None of the above.

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Questions 6-8 refer to the following table, which shows marginal abatement costs (MAC) in dollars for three different firms (assume these are the only firms in the economy). Assume each firm would pollute 8 units if left unregulated. Abatement Firm A’s MAC Firm B MAC Firm C MAC 1 2 1 4 2 3 2 5 3 4 3 6 4 6 4 8 5 8 6 10 6 10 8 12 7 13 10 14 8 16 12 17 6) Suppose the government imposes a pollution charge that brings about a total of 12 units of abatement. What would the total abatement costs be? A) 45 B) 46 C) 47 D) 48 E) 49 7) How many pollution permits would have to be issued for a tradable permit scheme to lead to an equilibrium price of $10 for a permit? A) 6 B) 7 C) 8 D) 9 E) 10 8) Suppose the government sets a standard requiring these firms to each abate 2 units of pollution. What would the total abatement costs be? A) $10 B) $17 C) $81 D) $82 E) None of the above.

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9) A tradable pollution permit scheme is good policy because I. the equilibrium abatement level occurs at lowest cost to society. II. all firms do the same amount of abatement in equilibrium. III. the government achieves its abatement target even if it doesn’t know firms’ abatement costs. A) I and II only. B) I and III only. C) I only. D) II only. E) III only. 10) Which of the following is true about a public good? I. It is any good that is paid for by the government. II. It is non-excludable. III. It is rival. A) I only. B) II only. C) III only. D) II and III only. E) I, II, and III END SECTION 1. Answer each question as clearly and concisely as possible on the exam paper. Use of carefully labeled diagrams, where appropriate, is strongly encouraged. Section 2: Short Answers

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Question 1 refers to the diagram below.

1. 9 points total Consider the market illustrated above, where an externality is present. a) 3 points On the diagram above, shade in the area representing deadweight loss in equilibrium. Clearly label the equilibrium and efficient quantities in this market. The efficient quantity is where MSB=MSC. The equilibrium quantity is where MPB=MPC. DWL is the area bounded by MSB, MSC, the equilibrium quantity, and the efficient quantity. b) 3 points Consider the optimal (social welfare maximizing) per unit tax or subsidy to correct the market failure. Which would you choose—a tax or a subsidy? Clearly illustrate and label

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the amount of the optimal per unit tax or subsidy in the diagram above (obviously you can’t give a number, so just illustrate the amount). Since it’s a negative consumption externality, there is too much quantity in equilibrium. To reduce quantity demanded and quantity supplied, we should impose a tax. The optimal tax, t*, is equal to marginal external cost (the distance between MSB and MPB) at the efficient quantity. Note that t* is denoted as a vertical distance (because we measure dollars per unit on the vertical axis). c) 3 points Clearly illustrate (on the diagram above) total government expenditure (in the case of a subsidy) or revenue (in the case of a tax) under this optimal policy. Government revenue is given by the per unit tax times the quantity purchased when the tax is in place (if we’ve picked t* correctly, this will be the efficient quantity). This is given by rectangle ABCD in the diagram above. Question 2 refers to the diagram below

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2. 11 points total Assume there are two consumers in the market for a public good. One has the individual demand curve D1 and one has the individual demand curve D2. Assume that provision of the public good costs $50 per unit. a) 4 points Draw the marginal social benefit curve for this market on the diagram above. b) 3 points Write the equation for the marginal social benefit curve. MSB=150-(3/4)Q c) 4 points Find the efficient quantity of provision. You must show your work to get credit. You can get partial credit for illustrating the efficient quantity on the diagram. Note that the answer won’t necessarily be an integer. MSC=MSB 50=150-(3/4)Q -100=-(3/4)Q Q=400/3

END SECTION 2. END OF EXAM.