ECO 324: Environmental Economics

Answers to Assignment 1 (Chapters 1-3)

Chapter 1: The Role of Economics in Environmental Management
(6 points)
(1) Explain the term environmental economics (1 point)
A field of study concerned with the flow of residuals from the economy to
the environment (or from economic activity back to nature).
(2) Explain the term nonpoint source (1 point)
A source that cannot be identified accurately and degrades the environment
in a diffuse, indirect way over a broad area.
(3) Page 22 of textbook: 1. a. (i) (2 points)
1. a. State how each of the following factors affects the materials balance
model: (i) population growth
Suggested answer: Population growth is expected to increase the materials
flow. An increased population implies a larger consumer group and hence an
increase in the demand for goods and services. As production is expanded to
meet that demand, more resources are called forth from nature. The flow of
residuals from economic activity back to nature also increases, both from
production in the form of industrial wastes and from the consumption of
goods and services.
(4) Page 23 of textbook: 4. (2 points)
4. Use your basic knowledge of economic principles to discuss how the
market premise operates under the "polluter-pays principle."
Suggested answer: The "polluter-pays principle" is based directly on the
incentives that drive market activity. Specifically, a price is assigned to
pollution, and the polluter is made to pay this price for every unit of
contamination released to nature. In theory, the price is set to cover any
damages to health or the ecology associated with any contamination. Hence,
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the "full costs" of production are captured within the market transaction.
Furthermore, since costs erode profits, the profit-maximizing producer has
an incentive to reduce the amount of polluting residuals released.
Chapter 2: Modeling the Market Process: A Review of the Basics
(7 points)
(1) Page 50 of textbook: 2. (1 point)
In 1995, the Food and Drug Administration published new labeling
standards for bottled water. (The full text of the final rule can be found at
http://cfr.vlex.com/vid/165-110-bottled-water-19705533). Prior to that time,
bottlers could sell regular tap water under a bottled water label. In fact, the
FDA estimated that approximately 25 percent of the supply of bottled water
was nothing more than ordinary tap water. Consider how these tougher
standards eliminated 25 percent of the supply of bottled water. If market
demand is unaffected, what qualitative impact would this labeling change
have on equilibrium price and quantity for bottled water? Support your
answer with a graphical model.
Suggested answer: Given the reduction in the supply of bottled water, the
equilibrium price should rise and the equilibrium quantity should decrease.
[The graph should show a left shift of the market supply curve and the
qualitative effect on equilibrium price and quantity.]

S'
2

S
PE '
PE
D

QE'

QE

(2) Page 50 of textbook: 3. (I simplified part c.)

Reconsider the implications of the revised labeling standards discussed in
Question 2 in the context of the hypothetical market for bottled water
modeled in the text. Recall that the market demand and market supply
equations are
QD = 100P + 1150 and QS = 400P 100,
where PE = $2.50 and QE = 900.
Now, suppose the change in standards results in a new market supply
of QS'= 400P 350, with no change in market demand.
a. Determine the new PE' and QE' for bottled water. Do your results agree
with your intuitive answer to Question 2 on page 50 of textbook? (2
points)
Suggested answer: QD = QS'
100P + 1150 = 400P 350
PE '= $3.00
and QE '= 850
So, PE ' (which is $3.00) > PE (which is $2.50), and QE ' (which is 850) < QE
(which is 900). The equilibrium price rises and the equilibrium quantity
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decreases. Yes, the results agree with my intuitive answer to Question 2 on

page 50 of textbook.
b. Graphically illustrate the market for bottled water before and after the
change in labeling standards. Be sure to label all relevant points. (2
points)

c. (This part is different from part c in your textbook.) Only calculate

consumer surplus and producer surplus after the change in labeling
standards. (2 points)
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Suggested answer:
CS = the area of AEB = x 850 x ($11.50 $ 3.00) = $ 3,612.50
PS = the area of BEC = x 850 x ($3.00 - $0.875) = $ 903.125
Chapter 3: Modeling Market Failure
(7 points)
(1) Page 77 of textbook: 1. (1 point)
Use economic analysis to evaluate the following statement: The only amount
of acceptable pollution is no pollution at all.
Suggested answer: We should recognize the flaw in assuming that the
optimal level of pollution is zero. While this may be the case in certain
instances, it is the exception rather than the rule.
The general solution is that the optimal level of abatement occurs where the
associated marginal social benefit is equal to the marginal social cost. This
optimal level is not necessarily zero.
From a general perspective, abating at the 100 percent level to reduce
pollution to zero involves prohibitive opportunity costs. These include the
forgone production and consumption of any good generating even the
smallest amount of pollution. Given our present technology, a zero-pollution
world would be one without electricity, advanced transportation systems,
and virtually all manufactured products. It makes little sense to argue for the
elimination of all pollution in our environment.
(2) Page 77 of textbook: 3. (both a. and b.)
Assume that a small town uses a referendum to overcome the free-ridership
problem and determine how its residents might value a new water filtration
system for its public water supply. The voting results are aggregated by the
towns two districts, yielding the following demand estimates:
District 1:

Q = 160 20P1
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District 2:

Q = 60 5P2,

where Q is the expected percent of copper to be filtered by the system and P

is the price in millions of dollars.
a. Based on these estimates, determine the towns market demand for this
public good, the new filtration system. (2 points)
Suggested answer: Because this is a public good, the two demands must
first be written in inverse form and then summed. The reasoning is that,
for a public good, each demander is expressing a willingness to pay for
the same quantity. The inverse demand equations are:
P1 = 8 0.05Q
P2 = 12 0.2Q
Summing these yields the market demand, which is P = 20 0.25Q
b. If the market supply for the system were P = 6 + 0.15Q, what would be
the equilibrium price and quantity for the town? (2 points)
Suggested answer: Equate the market demand and market supply and
solve, as follows:
20 0.25Q =
0.4Q =
QE =

6 + 0.15Q
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35 percent

Substitute QE into either equation to find PE as follows:

PE = 20 0.25(35) or 6 + 0.15(35) = $11.25 million
(3) Page 77 of textbook: 5. (only a.)
A New Hampshire textile mill releases pollution into nearby wetlands, and
the associated health and ecological damages are not considered in the
private market. Suppose you are an environmental economist working with
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the following marginal benefits and costs for this market, where Q is
thousands of pounds and P is price per pound.
MPB = 800 0.5Q

MPC = 20 + 0.3Q

MEB = 0

MEC = 0.4Q

a. Find the competitive equilibrium, QC and PC, and the efficient

equilibrium, QE and PE. (2 points)
Suggested answer: Competitive equilibrium is found where:
MPB =
800 0.5Q =
0.8Q =
QC =

MPC
20 + 0.3Q
780
975 thousand pounds

PC = 800 0.5(975) or 20 + 0.3(975) = $312.50

Efficient equilibrium is found where:
MSB = MSC
MPB + MEB = MPC + MEC
800 0.5Q + 0 = 20 + 0.3Q + 0.4Q
1.2Q = 780
QE = 650 thousand pounds
PE = 800 0.5(650) or 20 + 0.7(650) = $475