Environmental Economics NAME: _______

Exam 2
You have 55 minutes to respond to the following. Please use the space provided for your responses. There
is additional space on the back page.
1. It has been said that political decision makers use extremely high discount rates when conducting cost-
benefit analysis (CBA). This is particularly relevant when discussing global climate change and has been
blamed for the very slow progress on any real reductions in CO2 emissions. (i) Discuss how the chosen
discount rate can affect the outcome of any CBA and why global climate change is a good example of this.
(ii) Why do some consider it unfair to discount future costs and benefits at all? (16 points)

2. Your local community has proposed the construction of a wind farm to generate electricity and you have
been asked to conduct the CBA. Use a 5% discount rate and the information below to determine whether
the project is a “go”. Would your decision have changed with a discount rate of 2.5%? Be careful to show
your work. (12 points)

Construction Costs $1.5 billion for one year

Operating costs $200 million each year for the indefinite future
Wind power generated 2 billion kilowatt hours/year
Price of electricity $.04 per kilowatt hour
Productive farmland lost $10 million each year for the indefinite future
Jobs created $5 million each year for the indefinite future
3. Two paper plants are polluting the bay outside of Lobsterville with gunk. The authorities have decided
that to protect the lobster fisheries, total gunk emissions must be reduced to 8 tons per day. Plant A has
marginal emission reduction costs of 12 – xa dollars per day, where xa is the level of pollution, and is
currently emitting 12 tons. Plant B has marginal emission reduction costs of 12 – 2xb dollars per day,
where xb is the level of pollution, and is currently emitting 6 tons.
a. How many tons of gunk are being emitted in the unregulated situation? Graphically diagram this
situation. (10 points)

b. The authorities have decided that to protect the lobster fisheries, total gunk emissions must be reduced to
8 tons per day. In the hopes of improving lobster health in the entire bay, suppose the regulators decide that
each plant must reduce emissions by 5 tons (xa=7, xb=1). What is the total cost of this proposed clean-up?
Is this a cost-effective way to control emissions back to a level of 8? Why or why not? (12 points)

c. Now suppose that the regulators wish to reduce total emissions to 6 tons of gunk. What tax rate per ton
should they charge? In your figure, illustrate and calculate the taxes and clean-up costs that each firm
would bear under this proposal. (16 points)
4. What is the difference between physical and natural capital and how are they similar? Give a couple of
examples of each. How does the ecological perspective differ from standard economic analysis in their
beliefs about how to treat natural capital? Discuss their position on the issue of macroeconomic growth.
(12 points)

5. Uniform emission standards (a.k.a., “command and control” policy) have been the usual approach to
environmental regulation of American industry and incentive-based measures like a market for tradable
permits (Acid Rain Program) are a relatively new approach. Briefly explain how each approach works.
Then discuss why the tradable permit system is considered a preferable way to limit pollution. (12 points)

6. You have all conducted research in the form of your small paper describing the efforts of an
environmental organization that focuses their efforts on specific environmental problems. Use your
organization, or one presented by a colleague, to describe negative externalities and the open access
problem. (10 points)