Practice Questions for Topics 1-4:

1. Suppose that the production of wheat in a fixed-size parcel of land is given by

Y = 4L0.5 where L is the amount of labor devoted to farming.
(a) Taking market price of wheat, P, and the wage rate of labor, W, as given,
solve for the profit-maximizing choice of L and Y if the field is privately
owned. What is the rent (profits) generated by the field?
(b) Solve for the open access level of L and Y. (Hint: the profits (rent) under
open access regime is zero).
(c) Illustrates the open access and private property equilibrium in a diagram.

2. Suppose that there are N number of identical farmers and one open access
field. Each farmer supplies L units of labor for the total supply of NL. The
opportunity cost of labor is w. Total harvest Q = (NL)0.5 Under open access, each
laborer gets the average return to their labor.
(a) Set up the objective of each farmer (maximization problem).
(b) Determine each farmer’s optimal choice of labor.
(c) Assume that N  , in this case what is the optimal input of labor of each
farmer?
(d) Let N = 1. What is the optimal input of labor of each farmer.
(e) Explain the differences between the solutions (c) and (d).

3. A water source in B.C. can supply only 20 units of water/month. There are
two competing users of this water: urban and rural dwellers. The monthly
demands for the two groups are given by,
Urban: P = 30 − Q
Rural: P = 30 − Q/2.
(a) Draw a graph and find the allocation of water that maximizes social
(consumer) surplus. What is the level of price that can achieve this
allocation?
(b) Suppose that urban dwellers own water rights and sell them in a
competitive market. Draw a graph and find the equilibrium allocation and
price. Is this allocation different from part (a)?
(c) If the urban dwellers have only usufructory right (that is, they cannot sell
the water but can only consume), then how much will they consume?
(d) Which property right regime (private property right as in part (b) or
usufructory right as in part (c)) do urban dwellers prefer?
(e) If the urban dwellers can monopolize the market, what (uniform) price
would it charge and how much would it sell to the rural users?
(f) Repeat part (e) if the urban dwellers can perfectly price discriminate.
4. You are in the market for a new refrigerator for your company’s lounge, and
you have narrowed the search down to two models. The energy efficient model
(A) sells for $500 and will save you $25 at the end of each of the next five years in
electricity costs. The standard model (B) has features similar to the energy
efficient model but provides no future savings in electricity costs. It is priced at
only $400. Assuming your opportunity cost of funds is 5%, which refrigerator
should you purchase? Show your work.

5. In primitive societies the entitlements to use land were frequently possessory

rights rather than ownership rights. Those on the land could use it as they
wished, but they could not transfer it to anyone else. One could acquire a new
plot by simply occupying and using it leaving the old plot available for someone
else. Would this type of entitlement system cause more or less incentives to
conserve the land than an ownership entitlement? Explain.

6. Evaluate the following argument with the help of a diagram: “since pollution
is a negative externality, it would be socially optimal to declare illegal the use of
any production process that causes pollution.”

7. The US and Canada discussed the possible construction of a tidal power

project in the Pasamaquoddy Bay between Maine and New Brunswick sometime
ago. This project would have heavy initial capital costs but low operating costs
that would hold for a long time into the future.
(a) Although both used the same cost and benefit data, Canada concluded
that the project should not be built whereas the US concluded that it
should. Why?
(b) Whose approach (Canada or US) is consistent with the notion of
sustainability? Explain.

8. When private discount rate (firms’ discount rate) is different from social
discount rate (that used by the social planner or the government), the market
fails. Discuss.

9. A central element of weak sustainability theory is the assumption that human-

made (constructed) capital can effectively substitute for natural capital and the
services provided by ecological systems.
(a) Discuss the problems associated with this notion of weak sustainability.
(b) What can we or the government do to achieve a sustainable future in a
strong sense.

10. What are the problems associated with the traditional way of calculating
GDP? Why is the green GDP more consistent with the notion of weak
sustainability?