Question

The township of Cremona relies on groundwater for drinking water supplies. While groundwater supplies are plentiful, it has been discovered that concentrations of certain agricultural chemicals are at higher levels than recommended by public heath authorities. The township is considering making several costly investments to improve and protect groundwater quality.

The township has conducted a survey of its 100 residents to determine their willingness to pay for investments to improve groundwater quality. It was found that all residents have identical preferences. The marginal willingness to pay for water quality by each individual is estimated to be: MWTP = 25 – 5 Q, where MWTP stands for marginal willingness to pay in dollars and Q is a measure of water quality.   The marginal cost of water quality is estimated to be MC = 750 Q, where MC is in dollars.  

(a)What is the equation for the aggregate MWTP for water quality for Cremona?

What is the efficient quantity of water quality?   Briefly explain why is this considered the efficient quantity?

(b)Currently Q = 0. What is the total benefit to households of moving from Q= 0 to the efficient level of water quality? Describe your calculations.

(c)What is the total cost of supplying the efficient level of water quality? Describe your calculations.

(d)What is the net economic surplus from supplying the efficient level of water quality?   

(e)What is the efficient price that should be charged to each of the 100 rural residents for each unit of improved water quality? Briefly explain your logic.

Answer 1

A) Aggregate MWTP=100*(25-5Q)=2500-500Q

. efficient quality of water:

2500-500q=750

Q=1750/500=3.5

It is efficient because at this level aggregate marginal willingness to pay is equal to marginal cost .

B)TB=2500Q-250*Q^2

Total benefit at Q=3.5

TB=2500*3.5-250*3.5*3.5=5687.5

C) because MC is constant ,so

Total cost=750*3.5=2625

D)Net surplus= Total benefit- total cost

Net surplus=5687.5-2625=3062.5

E) Aggregate MB/MC at efficient level=750

Price charge to each household=750/100=7.5