Economics and the Environment

††††††††††††††††††††††††† Homework #1

 

1. Do the following using the various tools suggested in the question:

 

a. Using supply and demand, explain how the Brazilian government exemption of agriculture from taxation contributes to deforestation of the Amazon rainforest. (Note: Exemption of agriculture from taxation means that there will be an increase in demand by non-farmers for regular agricultural land as a tax write-off. As a result, many farmers will leave regular agricultural lands and move to the rainforest where agricultural land is cheaper. Why is it cheaper? Because government taxes unimproved land in the Amazon at a higher rate than improved land. This gives settlers an incentive to cut down the trees to lower their taxes.)

 

b. Suppose that (1) investment projects in the Amazon are eligible for a 75% tax credit by the Brazilian government; (2) a particular project develops land for 100 farms with the cost of clearing the land and building roads of $1,000 per farm; and (3) each farm would generate a net revenue stream whose present value is $400. Explain whether this project would be built in the absence of the tax credit and how the introduction of the tax credit affects this decision. Then show a supply-demand graph which illustrates this situation.

 

c. Suppose a cement plant emits dust which settles on nearby properties and causes various amounts of damage. Use a supply and demand framework to show the following:

 

(1) Show what kind of tax must be imposed to eliminate the externality. What kind of welfare loss is associated with such a tax? Show and explain.

 

2. Using information from the Stroup and Shaw article and the in-class discussion of subsidies do the following:

 

a. Stroup and Shaw argue that farm subsidies are one of the major reasons why wetlands are converted to farmlands. Show and explain how this occurs and why a welfare loss occurs.

 

 

 

b. Be sure you can explain how the combination of farm subsidies and acreage restrictions can lead to excessive pollution of streams and groundwater.

 

c. Stroup and Shaw argue that water subsidies to farmers in California cause many farming activities to move to California from other parts of the country (Midwest and South). Show how these subsidies result in a welfare loss and explain how it occurs.

 

d. People who build on coastal barriers where destructive storms frequently occur receive numerous subsidies that allow them to rebuild in the same place as often as they want. Show how this results in excessive development in such dangerous areas and how a welfare loss occurs (otherwise called a major misallocation of resources).

 

3. Use the Coase Theorem to solve the following problems and explain your answer.

 

†††† a. Suppose a cement factory and a laundry are located near one another. The paper mill (PM) has initial profits of $300,000 and the downstream farmer (F) $100,000 when neither has taken action to clean up the water. The farmer incurs damages from the water pollution of $25,000, the farmerís costs of cleaning the water are $15,000, and the paper millís costs of installing pollution control equipment are $35,000. Fill in the table and then show the results of applying the two property rules: Rule #1-the property rights to pollute the river belong to the PM; Rule #2-the farmer has property rights to the river and may sue to recover damages.

 

†††† b. Suppose the initial data on profits from part a. is the same but the paper mill drastically increases its pollution. The farmer incurs damages from the water pollution of $50,000, the farmerís costs of cleaning the water are now $40,000, and the paper millís costs of installing pollution control equipment are still $35,000. Fill in the table and then show the results of applying the two property rules: Rule #1-the property rights to pollute the river belong to the PM; Rule #2-the farmer has property rights to the river and may sue to recover damages.

 

 

 

4. Using the concept of marginal user cost developed in class do the following: In a three period model, suppose that U1 = $10, U2 = $12, U3 = $13, and r = 10%. Explain what must be done to achieve a dynamically efficient allocation of a resource over three time periods. Show your work.