Question

1)      Surrounding the Great Lake are four paper-mills, each producing 100 tons of paper per year. The paper is sold on the national market for $2 per ton, and including all the costs of production, costs for each firm are $1 per ton. Thus each firm earns a pure economic profit of $1 per ton. These paper mills require fresh water to operate and also produce a pollutant, which they dump into the Great Lake. New paper mills can also locate on the Great Lake, and produce at a base cost of $1 per ton. However, for each new paper mill which arrives (i.e., starting with the 5th mill), the water will become more polluted, and each firm will have to install a water treatment facility to obtain fresh water. This externality associated with new plants will raise the costs of paper production at all facilities, including the new one, by $.15 per ton for each new mill.

a. Fill in the table below to help you with your answers. which compares average revenues with average and marginal costs as new firms locate around the lake. (2 points)

# Mills	Total Revenue	Marginal Revenue	Average Revenue	Total Costs	Marginal Costs	Average Costs
4
5
6
7
8
9
10
11

b. Assume there is free access to the Great Lake. If paper mills will continue to locate as long as their is any economic profit to be earned, how many new mills will be built (i.e., the open access solution? (2 points)

c. What is the number of mills that maximizes total combined profits for the paper producers? (Hint: Average revenue remains constant at $2 (i.e, the efficient solution)?. What are these profits (resource rents) if the efficient solution? (2 points)

d. Suppose that government regulation reduced the number of mills by one from the number that would have resulted given free access. Show that the increase in profits to the remaining firms (the resource rent) is sufficient to compensate the firm that is denied access its lost profits. (2 points)

2) Suppose the state is trying to decide how many miles of a scenic river it should preserve. There are 100 people in the community, each of whom has an identical inverse demand function given by P=10-1.0q, where q is the number of miles preserved and P is the per-mile-price he or she is willing to pay for the q miles of preserved river. If the marginal cost of preservation is $500 per mile, how many miles would be preserved in an efficient allocation? (2 points)

Answer 1