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1.

(10 pts.) Suppose you are a regulator in charge of allocating water between residential
and agricultural users (farmers) in Southern California. You conduct a survey that finds
that under the cu
ent split the average residential water consumer would be willing to
pay up to $0.70 a gallon for the next gallon of water they consume while the increased
market value of crop production from the gallon of water (after farmers pay their costs)
to the most profitable farmer would be $0.20. Is the cu
ent allocation of water
economically efficient (circle: yes or no)? If not, in what direction should the water be
eallocated? In a sentence or two explain how we would expect these two quantities to
compare to each other if net benefits were maximized.
Answer:
Net benefit is maximized when the marginal cost of a gallon of water equals the
marginal benefit from that gallon of water. Here, the willingness to pay for a gallon of
water is the marginal benefit to the consumer of a gallon of water and farmer’s profit
from that gallon of water is the marginal cost, since this much increase in value of crop
production has to be given up for an additional gallon of water . This means that the
cu
ent allocation of water is not economically efficient. It will be efficient when
consumer’s willingness to pay for a gallon of water equals the increased market value of
crop production from the gallon of water. Water should be reallocated in such a manner
that the increase in market value of crop production from the gallon of water increases
whereas consumer’s willingness to pay decreases. This will happen when some water is
taken from the farmers and given to residential users. If net benefits were maximized
these two quantities would be such that the marginal benefit and marginal costs of them
are equalized.
2. (40 pts.) You are tasked with evaluating a project for reducing nutrient (nitrogen and
phosphorus) loading into the Gulf of Mexico (GOM). These nutrients make their way
into the GOM by way of the Mississippi River and primarily come from the runoff of
chemical fertilizer and animal manure from Midwestern farms. They can trigger
hypoxia (look it up) in the marine ecosystem, leading to “dead zones”, unattractive and
toxic algae blooms, and fish kills. A consultant for the National Oceanic and
Atmospheric Administration (NOAA) estimates the following “marginal benefit” curve
to fishermen and other affected communities for reductions in nutrient loads from their
aseline (2010) levels: MB = 10-.1Q. Q is in units of millions of tons of nitrogen
emoved (so 1=1,000,000 tons). MB is in millions of dollars per million tons (so 1 =
$1,000,000).
a. (10 points) Draw the marginal benefit curve for nutrient cleanup given the
equation above. Explain why the downward slope of this curve is reasonable
(hint: what does this imply for the extra damage done by each extra unit of
pollution as it is released into the ecosystem?). Finally, explain why this is a
“demand curve” for pollution abatement.

The downward sloping marginal benefit curve is due to diminishing marginal
enefit with increases in pollution abatement. The concept of diminishing
marginal benefit is similar to that of diminishing marginal utility, where with each
increase in the level of consumption, total utility increases but at a decreasing
ate. Similarly, here with each level of reduction in pollutants, total benefit
increases, but at a decreasing rate. This implies that with increase in pollution
abatement, the marginal damage decreases. This means that the extra damage
done by each extra unit of pollution reduces with the increase in nutrient cleanup,
or we can say that marginal damage increases with each additional unit of
pollution. If a marginal damage function shows the damage done by an additional
unit of pollution, then it will be upward...