Please explain your answers so I can understand the concepts. a)Use the TWO-PERI
ID: 1095202 • Letter: P
Question
Please explain your answers so I can understand the concepts.
a)Use the TWO-PERIOD model of resource extraction to explain/illustrate how an unregulated market optimally allocates a fixed resource over time. Be sure to identify the critical assumptions you need to get this result (e.g. discount rates, market structure, resource constraint, etc.).
b) Explain why firms choose output so that Marginal User Costs are equalized in present value terms over both periods.
c) Explain how to find the asset value of the resource in situ.
d) How do the private optimal extractions change if interest rates rise? What is the intuition?
e) Explain why an unregulated market over-exploits a resource relative to the socially optimal extraction. Show how to find the Deadweight Loss.
Explanation / Answer
a) n this economy we are going to assume that consumers face two periods, to-
day and tomorrow. Over their lifetime, the consumer receives income y:today,
and y0 tomorrow.1 Throughout this section all primed variable denote tomor-
row's value. The consumer must make choices on the amount of consumption
today, c, and the amount of consumption tomorrow, c0. The consumer also
chooses savings today, s, to carry forward to tomorrow that can be added to
tomorrow's consumption. We are are going to assume that the gross return
on savings is (1 + r). Given their income stream, consumers must choose c,
s and c0 over their lifetime.
In each period, the consumer faces a budget constraint. This budget
constraint simply says that in each period, a consumer's expenditures can
not exceed existing wealth. Since this household lives for two periods, we can
argue that our consumer faces two constraints. The constraints are written
as
c + s = y t
In the current environment a change in taxes in the current period lead to
a equivalent move in private savings and a equal but o setting moving in
government borrowing. Thus, the credit market remains in equilibrium at
the prevailing interest rate. Thus gives us two implications about tax cuts.
First, a decrease in current taxes need not generate a large increase in current
consumption which lines up with the permanent income idea from Freidman.
Second, tax cuts are not a free lunch, tax cuts in the current period imply
future tax increases to pay o the increase in debt generated from the original
tax cut.
B) A manufacturing firm, motivated by profit maximization, calculates the total cost of producing any given output level. The total cost is made up of total fixed cost (due to the expenditure on fixed inputs) and total variable cost (due to the expenditure on variable inputs). Of course, the total fixed cost does not vary over the short run