REVIEW QUESTIONS

1. Suppose QD = 200 − 4P and QS = 100 describe market demand and market

supply in a given market.
a. Algebraically find equilibrium price and quantity, and support your answer
graphically.
b. What is unusual about this market? Give an example of a good or service that
might be characterized in this way
2. 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.
b. Now determine the value of producer surplus and consumer surplus at
equilibrium.
3. 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.
a. Now, suppose the change in standards results in a new market supply of QS
= 400P − 350, with no change in market demand. Determine the new PE and
QE for bottled water. Do your results agree with your intuitive answer to
Question 2?
b. Graphically illustrate the market for bottled water before and after the change
in labeling standards. Be sure to label all relevant points.
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?

4. Suppose that the state of Connecticut is attempting to set a water quality

standard, where water quality is measured as the percent of mercury abated (A),
and the marginal social benefit
(MSB) and marginal social cost (MSC) of abatement have been estimated as
follows:
MSB = 40 -0:1A MSC= 36 + 0.25A
The state’s department of environmental protection sets the standard at 20
percent. Is this standard set efficiently, too stringently, or too leniently? Explain
briefly.
5. It is well documented that the carbon monoxide (CO) emissions from combustible
engines increase in colder climates. This implies that the associated damages
are expected to be less severe in summer months than in winter. Nonetheless,
air quality control authorities use a standard for CO that is uniform throughout the
year with no allowance for seasonal effects. Use this information and the
following model to answer the questions
MSB of CO abatement in winter = 350 − 0.5A
 MSB of CO abatement in summer = 140 − 0.2A
MSC of CO abatement = 0.2A
Where A is the level of CO abatement.
a. Graph the MSB and MSC functions on the same diagram.
b. Assume the government sets a uniform standard for winter and summer at A =
500. Support or refute this policy based on the criterion of allocative efficiency,
using your model to explain your response.
c. If you were in charge of setting policy for CO emissions, what action would you
recommend to ensure allocatively efficient outcome across the two seasons?
6. Assume that two power plants, Firm 1 and Firm 2, release sulfur dioxide (SO2) in
a small urban community that exceeds the emissions standard. To meet the
standard, 30 units of SO2 must be abated in total. The two firms face the
following abatement costs:
MAC1 =16 + 0:5A1 MAC2 = 10 + 2:5A2
Where costs are measured in thousands of dollars.
a. Prove that a uniform standard will not meet the cost-effectiveness criterion.
b. Determine how the abatement levels should be reallocated across the two
firms to minimize costs
7. Suppose that a chemical manufacturing plant is releasing nitrogen oxides into the
air, and these emissions are associated with health and ecological damages.
Economists have estimated the following marginal costs and benefits for the
chemical market, where Q is monthly output in thousands of pounds and P is
price per pound.
MSB = 50 – 0.4Q MSC = 2 + 0.4Q
MEB = 0 MEC = 0.2Q
a. Find the competitive equilibrium, QC and PC, and the efficient equilibrium, QE
and PE.
b. Find the dollar value of a product charge that would achieve an efficient solution.
8. Assume that the U.S. market for some inorganic chemical is modeled as follows,
where Q is in thousands of kilograms, P is price per kilogram, and there are no
consumption externalities:
MSB = 90 − 0.5Q MSC = 30 + 0.3Q
MEC = 0.2Q
a. Find the competitive equilibrium.
b. Find the efficient equilibrium.
c. Determine the dollar value of the Pigouvian tax that would ensure an efficient
equilibrium.
9. In 1996, Michigan launched a voluntary emissions trading program, which allows
polluters to achieve cost-effective solutions when meeting requirements of the
U.S. Clean Air Act. (For more on this program, visit www.michigan.gov/deq, and
click on Air, Assessment and Planning, and Emissions Trading.)
Suppose that Michigan’s objective for two major firms in an urban area is a 16
percent reduction in carbon monoxide (CO) emissions and that each firm faces
the following costs:
Firm 1: TAC1 = 1,000 + 2.5(A1)2
MAC1 = 5A1
 Firm 2: TAC2 = 500 + 1.5(A2)2
MAC2 = 3A2
Where A1 and A2 represent the percentages of CO emission abatement
achieved by firm 1 and firm 2, respectively, and TAC and MAC are measured in
thousands of dollars.
a. Calculate the TAC and MAC for each firm if a uniform abatement standard
were used.
b. Based on your answer to part (a), is there an economic incentive for the
sources to participate in the trading program? Explain.
c. Quantify the cost savings associated with a cost-effective abatement
allocation that could be achieved through trading.
d. At what price must each tradable permit be set to achieve the cost-effective
solution
10. Suppose the federal government is considering an air quality policy initiative that
would effectively increase abatement (A) of ozone from 10 percent to 20 percent
and that the marginal social benefit (MSB) of ozone abatement in millions of
dollars has been estimated as MSB = 120 − 2.5A. Determine the dollar value of
incremental benefits associated with this initiative
11. Suppose the MSC of cleaning Puget Sound is modeled as MSC = 10 + 1.4A,
where A is the percentage of phosphorus abated and MSC is measured in
millions of dollars.
a. Find the incremental costs of a policy initiative that increases the phosphorus
abatement level from its baseline of 30 percent to 45 percent.
b. Graphically illustrate using the MSC function, labeling clearly where
incremental costs are shown.
c. Repeat part (b) using the TSC function directly.
12. Suppose the TSC of mercury abatement has been estimated as TSC = 20A +
2.4A2, where A is a percentage of mercury abatement, and TSC is in millions of
dollars. Find the incremental cost of a statewide policy that would increase
abatement from 5 to 10 percent, and illustrate graphically.
13. Assume you are responsible for assessing whether the air quality standard for
carbon monoxide (CO) is set at the efficient level for some region. To accomplish
this task, you have estimated the following marginal benefit and marginal cost
functions for CO abatement:
MSB =20 +0:25A
MACmkt = 6 + 0:25A
MCE = 2 + 0:1A
Where A is the percentage of CO abatement, and MSB, MACmkt, and MCE are
measured in millions of dollars.
a. Find the MSC of abatement function.
b. Solve for the efficient level of abatement.
c. Show the importance of the MCE by determining the effect on the solution if
these government costs were ignored. Support your answer algebraically and
graphically.