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ECONOMICS3332

Resource Economics, Winter 2013

Dalhousie University

Assignment #2

Professor M.L. Cross

Date due: Wednesday, March 27.

Each of the questions in this assignment is weighted equally. This assignment, like much of

what we have done in ECON 3332, employs the equimarginal principle.

The economic theory of the mine characterizes an optimum pattern for extracting an exhaustible

resource over time. Some resources, such as energy, cannot be recycled. Others, such as copper or

iron, can be recycled. Petroleum provides both types of resources. When petroleum is used as fuel,

it cannot be recycled. But plastic is manufactured from petroleum and plastic can be recycled. With

this in mind consider questions in Part I. (Tientenberg, Chapter 8, discusses recyclable resources.)

Part I

1. Suppose a limited stock of an exhaustible resource is available. Is it technically possible for

recycling to completely eliminate the constraint imposed by an exhaustible stock? Why or why

not?

2. Suppose that the total available amount of a nonrenewable resource is 1000 tons. The

resource can be recycled 95 percent of the resource can be recovered for the next round of use

each time the resource is recycled. In addition, suppose that recycling can continue into the

infinite future. What effect does recycling have on the total amount of the resource that is

available? Show your calculations.

3. Now suppose a firm is manufacturing plastic garbage cans. The firm can make garbage cans

from either recycled plastic or new plastic manufactured directly from petroleum or any

combination of the two – the two types are perfect substitutes. However, new plastic and old

plastic have different requirements for storage, transportation, and sorting. Therefore, the

marginal cost (MC) of garbage cans made from new plastic is:

MC1 = 2q1

The marginal cost of garbage cans made from recycled plastic is:

MC2 = 40 + 0.4q2.

The quantity of garbage cans made from new plastic is represented by q1, and q2 represents

garbage cans made from recycled plastic. The market for garbage cans is perfectly competitive.

Price is determined by the following inverse market demand function for garbage cans:

P = 40 – (q1 + q2).

How many garbage cans will be produced from new plastic and how many will be manufactured

from recycled plastic? Show your calculations and briefly explain your results. (Hint: Assume

that all garbage cans are made from new plastic. Will the marginal cost of cans made from new

plastic exceed the marginal cost of cans made from recycled plastic when the market is in

perfectly competitive equilibrium?)

4. Now, suppose the inverse demand function for garbage cans is P = 80 – 0.5(q1 + q2). Marginal

cost remains as defined in in problem (3). How many garbage cans will be manufactured from

new plastic? How many will be made from recycled plastic? Show your calculations and

explain your results. (Hint: When the market is in perfectly competitive equilibrium and the

firm is maximizing profits, it must be the case that P = MC1 = MC2. Why?)

Part II

Questions in Part II provide a simple example about the pricing of electricity. The example does

not include issues such as fluctuations in demand during a 24 hour cycle or during a seasonal

cycle, whether electrical utilities are nature monopolies, etc.

Let P represent the price of electricity in cents/kWh and Q represent the quantity of electricity in

millions of kWh/day. Suppose that the inverse demand function for electricity is

P = 12 – 0.5Q.

Assume that up to 3 million kWh/day can be generated by gas turbines at a marginal cost of 5

cents, up to 6 million kWh/day can be generated by coal fired generators at a marginal cost of 4

cents, and up to 8 million kWh/day can be generated by a hydroelectric dam at a marginal cost of

2 cents. No other sources of electricity are available.

5. Graph the marginal cost curve and the demand curve. Graphs must be labeled accurately in

order to obtain full credit.

6. What is the economically efficient price and quantity of electricity? Explain.

7. What is the economically efficient quantity of electricity to produce from each of the three

sources? Explain.

8. Now suppose the paper company announces that if it can obtain 2kWh/day of electricity at a

price of 2 cents/kWh, it can open a paper plant which will provide more jobs. The company

argues that the available generating capacity can provide more electricity than current users are

demanding. Further, according to the company, it is appropriate to provide the company with

electricity at 2 cents/kWh because that is the marginal cost of producing hydroelectricity from

the lowest cost source. Is it economically efficient to sell electricity to the paper company at a

price of 2 cents/kWh? Explain briefly.