Quiz II Envecon 1 2016 Peter Berck

1. (2 pts) Draw a picture with a U-shaped AC, AVC, and an increasing MC. (2pts) Explain why the minimum point of AVC the shutdown point. (1pt) What is the firms supply curve? (2pts) On your diagram, show the firm’s profits when the price is above the minimum point of average cost.

1) Please find AC, AVC and MC in the above graph.

- The vertical gap between AC and AVC must be diminishing

- MC must cross AC and AVC at their bottom points

2) The minimum point of AVC is the shutdown point because,

- In short run, the firm compares its revenue with variable cost. If revenue>variable cost, the firm will keep running; otherwise, it will choose to shut down.

- when price is below the shutdown point, revenue<variable cost, the firm’s profit is greater than -FC;

- when price is above the shutdown point, revenue>variable cost, the firm’s profit is smaller than –FC.

* To get full credits, students need to compare revenue with variable cost, or compare profits with –FC. No credits if students just simply compared revenue with FC.

* The shutdown point is not the zero-profit threshold. Any answer like “firms will shut down because the revenue below the point is negative”received no credits.

3) The firm’s supply curve is the MC above the shutdown point.

* 0.5pts off if students didn’t mention “above the shutdown point”.

4) Please see the above graph.

* Students who correctly labeled the quantity that the firm will produce at (q on the graph) received1pt.

2. (7pts) There is a new national monument north of Mt. Kahtadin in Maine. The area is just about to be opened to recreation. In a few paragraphs describe how you would determine the demand for this new recreational area. First, you need to choose one of the methods described in class and describe why you chose that method. Then you need to provide some detail as to how you would carry out your study.

Three optional answers:

Answer I (Preferred):

(1’) - CVM(Stated preference method)

(2’) -Reasons: not open yet, no actual data ; non-use value (2’)

(4’) - (i) describing a specific project or good the interviewee will be asked to value; (ii) randomly select your interviewee; (iii) describing a specific payment method; (iv) reminding the interviewee that their money can be used for several competing purposes; (v) asking them a willingness to pay question; (vi) hypothetical bias/ conducting a debriefing to ensure the respondent understood the questions or check whether protest responses were made. (1pt for each, full credit for any four of the six)

Answer II:

(1’) - TCM(Revealed preference method)

(2’) -Reasons: to avoidhypothetical bias and any other disadvantage of CVM; use-value (2’)

(4’) -(i) getting the relationship between visits/capita and total costs (2’) – select another place nearby and collect the data of visits to that place; use regression methods to estimate the the relationship between visits/capita and total costs; (ii) setting different levels of entry fee, addingeach assumed entry fee to the total cost then calculating the number of visits (1’); (iii) plotting admission fees against number of visits to draw the demand curve (1’)

Answer III:

(1’) – TCM mixed with CVM (Not a typical revealed preference method)

(2’) -Reasons: not open yet, no actual data; use-value (2’)

(4’) -(i) getting the relationship between visits/capita and total costs via conducting a CVM survey (2’); (ii) setting different levels of entry fee, addingeach assumed entry fee to the total cost then calculating the number of visits (1’); (iii) plotting admission fees against number of visits to draw the demand curve (1’)

3. In the diagram below the price of “other stuff” is 3. The bundles on the isoquant shown make output Q*.

a. (2) Without regulation, what input bundle does this firm choose? What is the cost of making Q*?

The cost is 80*3=240.The chosen input bundle is (20, 40). Students are allowed to read the chosen bundle at different coordinates, but they must keep the cost to be 240. For example, (19, 42) is allowed, but (19, 43) is not.

b. (3) Use the diagram to explain what the firm would do if it were regulated with a technology based effluent standard. What is the technological base for the standard? What is the chosen input bundle? What is the cost?

TBES: First find a technology that reduces emissions at a reasonable cost – Find out how much emissions would go down – Then set an emissions standard for that amount (14 units in air).

The cost is 90*3=270.The chosen input bundle is (14, 62). Students are allowed to read the chosen bundle at different coordinates, but they must keep the cost to be 270. For example, (15, 60) is allowed, but (14, 63) is not.

c. (2) Draw another line on this diagram and use it to find the price for clean air that would have the firm choose the same input bundle as it chose with a TBES. What is the price of clean air now? The cost of making Q*?

The line is drawn on the graph (1’).

The slope of the dashed line: (62-0)/(14-22)=-7.75. Thus the new price of air is 3*7.75=23.25. The new cost is 23.25*22=511.5. (1’)