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EC307: Resource and Environmental Economics

Summer Flexi Tutorial 1 Solutions
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Question 1
State how each of the following factors affects the materials balance model:
a. (i) population growth; (ii) income growth; (iii) increased consumer recycling actions; (iv)
increased industrial recycling; (v) increased use of pollution prevention technologies.
[In answering each part of this question, the student should make it clear that the ceteris
paribus condition is being assumed.]
(i) 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.
(ii) Income growth should increase the materials flow, since higher income promotes
higher consumption levels, which will lead to the same chain of events discussed
in part (i).
(iii) Increased consumer recycling will divert some amount of household residuals
away from the flow back to nature. It should be noted, however, that this activity
reduces the residual flow only in the short-run, since recyclables eventually
become residuals as well. (The laws of thermodynamics confirm this assertion.)
(iv) Increased industrial recycling will have an effect analogous to what is described
in part (iii), except that the diversion of residuals arises from changes in producer
behavior rather than consumer behavior. It is also true that increased industrial
recycling may provide producers with alternative inputs that will slow the demand
for raw materials drawn from nature.
(v) Increased use of pollution prevention technologies will reduce the flow of
residuals to the environment in both the short-run and the long-run, assuming
such practices are sustained.
b. Using the data in Table 1.2, graphically illustrate the relationship between a country’s per
capita GDP and its per capita municipal waste generation. What conclusion can you draw
from your graphical analysis?

Graph:
 As discussed in the text and as indicated by the slope of the trend line in the above
graphic, there appears to be a positive relationship between a nation’s GDP (or its
industrialization) and its waste generation. If the data for Norway were removed, the
positive linear relationship would be stronger.

One reservation with the above analysis is that there may be many contributing factors
(e.g., social, economic, or political) that are not captured by this simple graphic.

Question 2
Discuss what is meant by the market premise operates under the "polluter-pays principle."
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, 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.
Question 3
Describe a real-world government policy that creates a market surplus and explain the
efficiency implications and rationale for such a policy.
Think regarding government price control. As long as the control is held above equilibrium
price, a surplus will result. A classic example is the minimum wage law in the relevant market is
the supply and demand for unskilled labor.
The government intervention will affect the signaling mechanism of price. By forcing price
above equilibrium, suppliers are willing to bring more of the good or service to market than
demanders are willing and able to purchase. In the context of labor markets, the minimum wage
creates unemployment of unskilled laborers.
Often, the motivation for such price controls stems from equity issues rather than efficiency
concerns. Establishing a minimum wage is a policy aimed at protecting workers from
exploitation and at assuring all workers at least a basic standard of living.
Question 4
Discuss using examples of how the System of National Accounts endorsed by the United
Nations fails to properly capture activity that harms the environment. Now, suggest a way
to quantitatively correct the flaw in the particular case that you described.
The degradation of any natural resource due to pollution, or the clearing of forests for industrial
development, are excluded from national income measures, or the health care costs linked to
toxic exposure that improperly inflate GDP. Depending on the example, the correction may be to
estimate the value of the lost resource and deduct it from GDP or to deduct the actual health care
cost for toxic exposure from the GDP measure.
Question 5
Explain two economic incentives that would encourage firms to research and implement
“design for recycling” programs.
Subsidies for researching such issues as identifying recyclable materials or devising better
methods for sorting plastics, or grants for appropriate capital investment in recycling or sorting
equipment, or tax deductions for designated expenditures on dismantling, recovery, recycling, or
sorting.
Question 6
Suppose the market for organically grown wheat is modeled through the following market
supply and demand functions:
P = 10 + 0.5QS and P = 22 ‒ 2.5QD,
where QS and QD are in millions of bushels, and P is price per bushel.
a) Find the market equilibrium price, PE, and market equilibrium quantity, QE.
 Market equilibrium arises where QS equals QD,
Equilibrium: QD = QS
(Recall your EC102 knowledge; Make QS and QD subject of the formula)
QE = 4 million bushels and PE = $12 per bushel.
b) Compute the value of producer surplus and consumer surplus at
equilibrium.
Consumer surplus is found as the area above equilibrium price up to the demand
curve aggregated over all units of output sold, which is $20 million. Producer
surplus is found as the area between equilibrium price and the supply curve
aggregated over all units sold, or $4 million. (Hint: Try to plot the demand and
supply equation)
Question 7
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 + 1,150 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?
PE ' = $3.00 and QE ' = 850. Yes.

b. Graphically illustrate the market for bottled water before and after the
change in labeling standards. Be sure to label all relevant points.

[Students should present a supply and demand model with numerical values assigned to
the intercepts and the equilibria that correspond to the specific equations given. The
graph should illustrate the decline in market supply and the quantitative effect on PE and
QE.]
c. Compare the values of consumer surplus and producer surplus before and after the
change in labeling standards. Is this result expected? Why or why not?
 Consumer Surplus Producer Surplus
Before $4,050.00 $1,012.50
After $3,612.50 $ 903.125
Both the increase in price and the decline in quantity tend to lower consumer surplus,
which means that a lower consumer surplus is expected in this case. However, predicting
the change in producer surplus is more difficult, since the price rise should increase it, but
the quantity decline should decrease it.
Question 8
In the competitive market for organic corn, market demand is QD = 340 – 2P and market
supply is QS = 100 + 4P, where P is the price per bushel, and Q is market output in
thousands of bushels. Each individual farmer faces a marginal cost function of MC = 10 +
3q, where q is the single farmer’s output level in thousands.
a) What is the equation for the demand (which is also MR) faced by the individual farmer?
The individual competitive farm must accept the market-determined price of organic corn
as given. This is the equilibrium or market-clearing price found where QD = QS for the
entire market, as shown below.
QD = QS
Substituting: 340 – 2P = 100 + 4P
Solving: 6P = 240, or P = $40 per bushel.
Since the competitive firm has no control over price, it faces a horizontal demand curve
at the $40 price, so the equation for demand (and MR) it faces is simply P = MR = $40.
b) Based on your answer to part (a), find the profit-maximizing output level for each
farmer.
The profit-maximizing output level for each farmer is found where MR = MC. Find the
result as follows:
MR = MC
Substituting: 40 = 10 + 3q
Solving: 3q = 30, or q = 10 thousand bushels

c) At an output level of 8 thousand bushels, explain in terms of both marginal profit

and total profit why the individual farmer should expand production.
At an output level of 8 thousand bushels, the farm’s MR = $40, but its MC = 10 + 3(8) =
$34. At this point, the farmer’s marginal profit (M), which equals MR – MC, is $6,
which means that if the farm produces the 8000 th bushel of organic corn, its total profit
would rise by $6.