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explain in detailseco567 1. Consider a very simple two node model in which natural gas is produced in region A and is transported by pipeline

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1. Consider a very simple "two node" model in which natural gas is produced in region A and is transported by pipeline to region B. The price of natural gas in Region B is $6 per thousand cubic feet (Mef) and the price of transportation service from Region A to Region B is $1/Mef. a. If the market for producing gas in region A is perfectly competitive and there is a perfectly elastic supply of transportation service what will be the equilibrium price of natural gas in Region A? b. What will happen if the government places a cap of $4/Mof on price that producers in Region A can charge for the natural gas they produce? Discuss how your assumptions about the shape of the competitive supply curve in Region A affects your answer. 2. Now consider a more complex natural gas supply and demand system such as the one we have in North America. There are multiple gas production areas and many consuming areas that are remote from production areas and rely on pipelines to transport gas to them. a. Assume that the price of natural gas at Henry Hub (Louisiana --- a gas producing area) is $5/Mof and assume that the price of natural gas in Los Angeles (a gas consuming area) is $4/Mef. Explain how such a price pattern can emerge? b. What incentives are there to expand pipeline capacity from producing areas in the Western U.S. to consuming areas in the Eastern U.S. 3. The United States maintains a Strategic Petroleum Reserve (SPR) that now contains 700 million barrels of crude oil. a. What factors would you take into account to design a policy to determine when and how much oil is released from the SPR? b. How would the expected supply behavior of OPEC affect your policy design?1. Suppose that you are trying to determine whether OPEC is an effective cartel. Suppose there is an exogenous and unanticipated shock to world oil supplies --- c.g. political unrest that causes oil exports from Venezuela to fall to zero. Discuss how you would go about distinguishing between the following models of imperfect competition if you could observe market prices, output levels for individual countries, and the short run marginal oil production costs of individual countries before and after the demand shock. a. Textbook cartel b. Dominant firm/fringe firm c. Cournot (quantity) competition d. Perfect competition 2. If oil and natural gas are close substitutes discuss the effect of a negative shock to world oil supplies as in (1) on field prices, import prices, quantities, and market clearing conditions for natural gas sold in the U.S. under the following conditions: a. Field prices for natural gas produced in the U.S. and prices for imported gas are unregulated. Pipelines pass through the cost of the gas they purchase in the field in the prices they charge to local distribution companies. b. The field price of natural gas produced in the U.S. is subject to a price ceiling equal to the pre-shock domestic price of natural gas while imported gas prices are unregulated. Pipelines are required to charge the average prices they pay for domestic and imported gas to local distribution companies. c. The pipeline network in the U.S. was operating at full capacity prior to the supply shock.12. You can form a portfolio of two assets, A and B, whose returns have the following characteristics: Stock | E[R] Standard Deviation Correlation A 0.10 0.20 0.5 B 0.15 0.40 If you demand an expected return of 12%, what are the portfolio weights? What is the portfolio's standard deviation? 13. Your have decided to invest all your wealth in two mutual funds: A and B. Their returns are characterized as follows: . the mean returns are FA = 20% and FB = 15% . the covariance matrix is TA TB TA 0.3600 0.0840 TB 0.0840 0.1225 21 @ 2001, Andrew W. Lo and Jiang Wang 1.6 Risk & Portfolio Choice 1 QUESTIONS You want your total portfolio to yield a return of 18%. What proportion of your wealth should you invest in fund A and B? What is the standard deviation of the return on your portfolio? 14. In addition to the fund A and B in the previous question, now you decide to include fund C to your portfolio. Its expected return is fc = 10%. The covariance matrix of the three funds is TA TB TC TA 0.3600 0.0840 0.1050 TB 0.0840 0.1225 0.0700 TC 0.1050 0.0700 0.0625 Your portfolio now consists of fund A, B and C. You would like to have an expected return of 16% on your portfolio and a minimum risk (measured by standard deviation of the return). What portfolio should you hold? What is the return standard deviation of your portfolio? (Hint: You would need to use Excel Solver or some other optimization software to solve the optimal portfolio.) 15. You can only invest in two securities: ABC and XYZ. The correlation between the returns of ABC and XYZ is 0.2. Expected returns and standard deviations are as follows: Security | E[R] (R) ABC 20% 20% XYZ 15% 25% a) It seems that ABC dominates XYZ in that it has a higher expected return and lower standard deviation. Would anyone ever invest in XYZ? Why? b) What is the expected return and standard deviation of a portfo- lio that invests 60% in ABC and 40% in XYZ? c) Suppose instead that you want your portfolio to have an expected return of 19.5%. What portfolio weights do you select now? What is the standard deviation of this portfolio? 16. You have the same data as the previous question. In addition, you have a risk-free security with a guaranteed return of 5%. The tangency portfolio has an expected return of ?? and standard deviation of ??. (a) What weights are placed on ABC and XYZ in the tangency port- folio?1. Explain why the "optimal" level of COz emissions is not zero? 2. The government is trying to choose between an emissions tax system and a cap and trade system. (read the relevant sections of the Stern Review) a. Assume that the government is certain about the shapes and location of the marginal abatement cost and marginal damage cost functions associated with some pollutant. How would you decide whether to use an emissions tax system or a cap and trade system to internalize the pollution externality? b. Assume that the government is uncertain about the shapes and location of the marginal abatement costs and marginal damage cost functions associated with some pollutant. How would you now decide whether to use an emissions tax system or a cap and trade system to internalize the pollution externality. 3. You are doing a cost-benefit analysis to determine whether, how much, and when CO2 emissions should be reduced from "Business as Usual Levels" over the next 100 years. (read the relevant sections of the Stern Review) a. Explain why the discount rate chosen to calculate the present value of mitigation costs and damages of climate change can have a large effect on the results? b. What factors should go into choosing the correct discount rate.1. Explain why the "optimal" level of COz emissions is not zero? 2. The government is trying to choose between an emissions tax system and a cap and trade system. (read the relevant sections of the Stern Review) a. Assume that the government is certain about the shapes and location of the marginal abatement cost and marginal damage cost functions associated with some pollutant. How would you decide whether to use an emissions tax system or a cap and trade system to internalize the pollution externality? b. Assume that the government is uncertain about the shapes and location of the marginal abatement costs and marginal damage cost functions associated with some pollutant. How would you now decide whether to use an emissions tax system or a cap and trade system to internalize the pollution externality. 3. You are doing a cost-benefit analysis to determine whether, how much, and when CO2 emissions should be reduced from "Business as Usual Levels" over the next 100 years. (read the relevant sections of the Stern Review) a. Explain why the discount rate chosen to calculate the present value of mitigation costs and damages of climate change can have a large effect on the results? b. What factors should go into choosing the correct discount rate.1. An electric power system has the following mix of generating capacity installed on its network which is owned by several competing generating firms: Type Marginal Operating Cost Capacity Nuclear $15/Mwh 1000 Mw Coal $25/Mwh 2500 Mw Gas $60/Mwh 1500 Mw Turbine $80/Mwh 500 Mw a. Draw the competitive supply curve for the production of electric energy on this system b. Assume that demand is 3000 Mw and is completely price inelastic in the very short run. What would be the spot price in a perfectly competitive wholesale electricity market? c. Assume that demand is 4000 Mw and is completely price inelastic in the very short run. What would be the spot price in a perfectly competitive wholesale electricity market? d. Assume that demand is 6000 Mw at a price of $80, but that 600 Mw of this demand would be willing to be curtailed for a price of $4000/Mwh or more. What is the perfectly competitive market price in this case? 2. Describe how you would use the information above regarding the attributes of the generating capacity on this system, along with information about actual market prices and supplier behavior to measure whether or not market prices suggest that generators are exercising market power. 3. In New England, spot electricity prices in Maine are often much higher than are spot electricity prices in Boston even though they are part of the same regional network. How can you explain these price differences assume that the market is perfectly competitive.1. (36 points) Two firms, A and B, are competing in the production of a homogenous good. The good's marginal cost for both firms is equal, MC = $25. Assuming linear reaction functions, describe what would happen to output and price in each of the following situations if the firms are in (i) collusive equilibrium, (ii) Cournot equilibrium, (iii) Bertrand equilibrium. (a) (4 points for each of (i)-(iii)) The demand curve shifts to the left. (b) (4 points for each of (i)-(ii)) Because it invents a new and improved machine, the marginal cost at firm B decreases to $20. (c) (4 points for each of (i)-(iii)) Costs in the entire industry increase due to an increase in wages. Problem 1 by MIT OpenCourse Ware. 2. Problem removed due to copyright restrictions. This content is presented in audio form in the Solution Video for Problem Set 8, Problem 2 3. (28 points) Suppose a perfectly competitive labor market has a demand curve of [ = 120 - 2wr and a supply curve of " = Sw, where w is the wage rate is dollars and L is the quantity of labor in person-hours. (a) (2 points) What are the equilibrium values of the wage and employment? (b) (4 points) Suppose the government imposed a minimum wage of $14 per hour. Now what are the equilibrium values of the wage and employment? (c) (8 points) Repeat part (a), assuming now that the market is a monopsony. (d) (8 points) Repeat part (b), assuming now that the market is a monopsony. (e) (6 points) Does the imposition of the minimum wage decrease employment here under perfect competition? What about under monopsony? Give a brief intuitive explanation for your answer and why it may be different under the two different market structures. Problem 3 courtesy of William Wheaton. Used with permission. 4. (11 points) Suppose you face the following lottery. You can earn 1 of 3 possible grades in this class: an "A" , a "C", or an "F", with the following probabilities: 10' 10' IF = 10 Your current wealth (w) is $400. If you receive an "A", you gain (e-g. I pay you) $500. However, if you get an "F", you lose (e-g. you pay me) $300. If you receive a "C", you DO NOT GAIN OR LOSE anything. Assume your utility function, defined over wealth, is U(w) = v (w). (a) (6 points) What is your expected utility (EU)? [Hint: be sure to calculate your total wealth in each "state".| (b) (5 points) What is the certainty equivalent level of wealth (w*), that is, the guaranteed payoff at which a person is "indifferent" between accepting the guaranteed payoff and their expected utility from (a)

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