Problem Set 1. Introduction to Sustainable Development and Microeconomic Theory

EconS 326

1. Norway is endowed with human capital, physical capital and natural capital assets. One of the important natural capital assets for its economy is the available fish stock. a. If we wanted to obtain a measure of economic growth in Norway, what measure could we use? Explain at least one drawback to this measure. If we wanted to obtain measures of economic development in Norway, what measures can we use? b. Give an example of how a fishery can achieve each of the following: weak sustainability, strong sustainability and environmental sustainability. c. The Norwegian government wants to achieve sustainable development. Explain how sustainable development can be achieved and measured. d. The precautionary principle can be used to regulate pressures on the fish stock. What does the precautionary principle say with regards to protecting the fish stock? Explain one drawback of using the principle from a policymaker’s point of view.

Potential Responses:

a. Economic growth refers to changes in national per capita income or output and gross domestic product (GDP) or gross national product (GNP) are classic measures for a country. There are several drawbacks with using GDP or GNP as a measure of economic welfare: (1) it does not say anything about allocation of output and (2) does not fully capture all assets of the economy such as natural resources. There are also several drawbacks as a measure of economic growth as well because of problems with comparability across countries due to the exchange rate problem and differences in purchasing power. Economic development encompasses fundamental change in the structure of the economy so it includes measures of poverty, income inequality, freedom, governance, health, literacy, corruption, etc.

b. Weak sustainability – The aggregate value of the stock of the economy has to not decline. In this case, the value of fish stock can go down by harvesting more than the re‐growth rate as long as the profit from the harvest is reinvested in the growth of the value of other stocks in the economy that compensates for the value in the decline of the fish stock. Note you can also talk about the individual fish sector itself where there is a fish stock, human capital and physical capital. The idea remains the same where the total value of all assets within the fish sector should not decline.

Strong sustainability – Individual stock values in the economy must not decline. This implies the value of the fish stock does not decline. If price remains fixed, one can only harvest up the amount of new fish grown. One can harvest more than the new growth of fish as long as the price is also rising accordingly so that the value of the fish stock does not decline.

Environmental sustainability – Physical flow need to be maintained such that the amount of harvest need to be less than or equal to the amount of new fish. c. Sustainable development implies (1) maximization of economic welfare (which incorporates economic, environmental and social aspects) subject to (2) meeting a sustainability criterion. If we assume that the fish stock is privately owned and there are no market failures in this sector, we just let the market work on its own to maximize welfare. However, if there is market failure, we may need to employ some sort of regulation (we will go into this in more detail later on). One sustainability criterion we can use is the weak sustainability criterion. As long as aggregate stock of the economy does not decline when maximizing welfare, we will achieve sustainable development.

d. Given uncertainty in fish stocks over time, the precautionary principle cautions us to not drive the resource into extinction. Unfortunately, it cannot offer specific policy recommendations in terms of how to regulate the use of the stock and what the allowable catch limits should be.

2. Consider the following demand and supply relationships in the market for golf balls: Qd=90‐2Pg‐2Pt and Qs = ‐9+5Pg ‐2.5Pr where Pg is the price of golf balls, Pt is the price of titanium (a metal used to make golf clubs), and Pr is the price of rubber. If Pr = 2 and Pt = 10, calculate the equilibrium price and quantity of golf balls. Draw the supply and demand curves. Include in your drawing all relevant intercepts and both slopes of each curve.

In equilibrium Qd = Qs.

Thus, 90‐2Pg‐2Pt = ‐9+5Pg ‐2.5Pr. Solving for Pg, we have,

90+9+2.5(2) ‐2(10) = 5Pg + 2Pg

12 =Pg*

Substitute Pg* into either the demand or supply equation to arrive at Q*. Substituting into supply yields,

Q*=‐9+5(12) ‐2.5(2)  Q* = 46.

35 S

12 2.8 0.2 D ‐0.5

46 70 Q

3. Forecast how equilibrium price and quantity will change in each scenario below. a. Assume that the market for celphones is perfectly competitive. The development of a new technology allows the price of computer chips in celphones to decrease. Let us also assume, a new health study has conclusively proven that continued use of celphones can raise the risk of cancer by 25%. What will happen to equilibrium price and equilibrium quantity of celphones in this market? Use a graph to support your answer.

Price will drop but quantity is ambiguous.

S S’

D D’

? Q

b. You are an economist tracking price and quantity changes in the cattle market. Mad cow disease suddenly affects the cattle population. What will happen to equilibrium price and equilibrium quantity of cattle in this market? Use a graph to support your answer.

Quantity will decrease but price is ambiguous

4. The market for corn is currently perfectly competitive. The government wants to increase corn consumption and production so they decide to subsidize farmers. The subsidy is a constant amount given to farmers for every unit of corn they produce. Determine how the welfare of consumers, producers, the government and total welfare are affected (increase, decrease or unchanged) by the subsidy to farmers. Use a graph to show the effect of the subsidy and identify where welfare for the consumers, producers and the government are before and after the subsidy. Also identify the deadweight loss if any.

Consumer welfare increases – OLD CS = aef ; NEW CS = amj

Producer welfare increases – OLD PS = feh; NEW PS=bgh

Government welfare decreases = OLD Government welfare = 0; NEW Government welfare =‐(bgmj)

Total welfare decreases – OLD Total = aeh; New total = (aeh) – (egm); DWL =egm

a S g b S’ f e j m h n D

c k Q