ASSIGNMENT 3-28 Pollution policy -- more (1)

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ASSIGNMENT: POLLUTION CONTROL POLICY CONTINUED Wasteco Haulage generates 200 tons of emissions. It could spend money to reduce its emissions. If it were to undertake the amount A of abatement, its cost (reduced profit) would amount to C(A) = 40A + 4A 2 . The external benefit of abatement, in terms of reduced harm to the public from emissions, is measured in monetary terms by B(A) = 440A. How much abatement would Wasteco choose to undertake if it were unregulated? How much abatement would it undertake if it faced a tax of $200 per ton of emissions (1 unit of abatement = 1 unit less of emissions)? No abatement for no regulation. MC(A) = 40 + 8A A = 20 What is the socially optimal level of abatement that Wasteco should undertake? What is the correct Pigouvian tax on emissions that would induce Wasteco to undertake that amount of abatement? (see Lecture for 10-17). 440 = 40 + 8A A = 50 Pigouvian tax = 440 What is the equi-marginal principle? What does the theorem state? It states that the levels for all possible abatements will equalize the marginal cost of abatement. We would want the equalized marginal cost of abatement from all sources. When does application of the equi-marginal principle lead a firm to divide its abatement activities equally between two abatement plants that it owns? What has to be the case? If they have the same marginal cost of abatement. If this condition does not hold, but the firm still divides its abatement activities equally between two abatement plants that it owns, what is the consequence? The abatement will be in the lower cost plant Suppose Wasteco has two abatement plants. At one plant – the north plant, the abatement cost function is given by C N (A N ) = 40A N + 4A N 2 . At the other plant – the south plant – the abatement cost function is given by C S (A S ) = 20A + A S 2 . Wasteco is ordered by the EPA to reduce 1

its emissions from 200 to 100. How much abatement would it choose to do at the north plant and how much at the south plant? An + As = 100 40 + 8An = 20 + 2As 20 +200 – 2An = An An = 18 As = 82 Suppose that, instead of being ordered by the EPA to reduce its emissions to 100, the EPA imposes an emissions tax of $200 per unit of emissions. How much abatement would Wasteco choose to do at the north plant? How much would it choose to do at the south plant? What explains the difference in how much abatement is done at one plant versus the other? How much does Wasteco still emit (for which it pays the emissions tax)? Why doesn’t Wasteco do all its abatement at the south plant? Why doesn’t Wasteco abate all 200 units of emissions? MCN(An) = MC(As) = 200 An = 20 As = 90 On what grounds have some people argued that there should be the same emission standard for all firms in the same industry, or the same emissions tax for all firms in that industry? It can make a level playing field for all polluters and for all firms in the country, in all industries. What economic outcome necessarily occurs if all firms in an industry face the same emissions tax? They will all choose the same level of marginal cost and the abatement at that level. Does the same economic outcome necessarily occur if all firms in an industry face the same emission standard? No. 2

What is the criticism that has been made of NOx regulation for power plants and cars in the US? That they are not properly prioritizing between the power stations and cars. What factors does this criticism overlook? The fact that it is equally easy to regulate cars and power plants, car owners and power plants have the same cost of controlling emissions and that they would have equal way to marginal costs. When is it optimal to focus on just minimizing the aggregate abatement cost across an industry, and when is it not? If all emissions have same additional damage, and when it is not is when it has different values. Why is a globally uniform emissions tax acceptable for the emission of greenhouse gasses, but not for the emission of most other air pollutants? Because the damage depends on the total overall levels of pollutants. What is meant by the deadweight loss of a conventional tax on output (e.g., a sales tax)? How does that loss arise? It is the loss of the consumer and producer surplus minus the revenue from taxes. Normally, what type of tax does not generate a deadweight loss? A lump sum tax. Using a partial equilibrium analysis, does a Pigouvian tax on a polluting firm’s output generate a deadweight loss? Why not? Yes. What considerations go into a general equilibrium analysis of the effects of a tax that are omitted in a partial equilibrium analysis – just answer this in general terms. We consider the interaction between different sectors. In partial equilibrium, some factors such as labor are not considered. For example, Pigouvian taxes can make deadweight loss larger. 3

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What is meant when economists refer to the potential “double dividend” from an emissions tax? It means it corrects the market failure while raising revenue that can replace the loss in government revenue from deadweight loss. Would a general equilibrium analysis of an emission tax necessarily find that there is a double dividend? No, depending on the current tax levels an how optimal the Pigouvian tax is. Are an emission standard and an emissions tax likely to have the same impact on the adoption of new abatement technology ? No, a tax will cause more adoption. Is the monitoring of emissions equally important in practice with an emission standard as with an emission tax? No, for standard it is possible without monitoring while that is not true for tax. POLLUTION CONTROL POLICY IN PRACTICE What are the two criteria for judging the desirability of an emission standard (cap) versus an emission tax? Certainty of the quantity of reduction and the economic efficiency of emission reduction. By those criteria, is an emissions tax always superior to an emissions cap? No. What is the “polluter pays” principle? It means the polluters are responsible for the damage they cause. Where have environmental taxes been more accepted – the US or the EU? What might explain the difference? 4

EU, since they have different societies When countries have imposed emissions taxes, have those taxes always satisfied the requirements specified by Pigou? No, they did not, because of many limitations/. What is congestion charging? How does it work? It is a price on being at locations at times when congestion might happen. Apart from relieving traffic congestion, could congestion charging have any other benefit? It can reduce pollution and improve health. What is a cap and trade system? How does it work? It places a limit on how much firms can pollute individually, and that the firms can trade these permits. How does cap and trade resemble an emissions standard? It limits the amount of pollution. How does cap and trade resemble an emissions tax? It places a price on each unit of pollution. What difference do you think it could make if the permits are initially given away for free versus be sold/auctioned by the government? If the permits are sold they can raise revenue, if they are given for free there will be a resale market. If banking of unused emission permits is permitted, what does this mean? When might firms want to make use of the opportunity to bank unused permits? They can sell the permits in a future year and sell in the future if there is higher value than this year, or do some planning about long term production. 5

What does it mean to talk about the exercise of market power in an emissions market? Given an example of how market power might be exercised by a seller of permits? Given an example of how market power might be exercised by a buyer of permits? Some larger sellers can get too much market power and raise prices, while large buyers can put downwards pressure on prices. Where has cap and trade been applied? In the EU, 6

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