There is no difference when everyone is identical. All systems are equal

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1 PART I: Short Answer 5 marks each 1) What is the difference between an ambient and emissions standard; and what are the enforcement issues with each? Ambient set an air/water quality level. It is the true objective of any enviro policy. Emissions standards limit the pollutants thought to lower ambient quality. The problem with emissions is that it is only a Proxy for ambient quality. It requires knowledge of how the emissions lowers the quality. Ambient Standards would be more desirable since they are the true goal. However, they are harder to enforce. The polluter may not be anywhere near the location of the damage or there may be multiple polluters damaging the same area. Very high transactions costs. 2) Emission taxes and transferable permits are both incentive based pollution controls. Give an explanation and example for a case when taxes are preferred to TEP s and when TEP s would be preferred to Taxes. TEP s require a competitive market. If there is not enough competition, then a tax is preferred. Since TEP s based on aggregate quantities of emissions and taxes are not, TEP s are preferred when there is economic growth. Taxes control the output per firm but not the number of firms, so economic growth will lead to an increase in total emissions under a tax 3) If all firms are identical with respect to their levels of emissions and MAC s, which is system would preferred by society: uniform standards or giving each firm the same number of transferable permits (equal to the standard)? There is no difference when everyone is identical. All systems are equal 4) What is the Coase Theorem and what are the necessary conditions to ensure that it would be an effective manner of dealing with pollution problems? Coase: It does not matter who is initially allocated the property right. As long as rights are well defined, there will be trade that allocates the rights to the most valued use; This will work as long as there is small numbers and the damage is limited to a clearly defined group and all parties have good knowledge of the relevant costs. PART II: True/False/Explain. 5 marks each (no marks without explanation) 5) Suppose, for a PUBLIC good, Skippy has MWTP 1 = 80 4Q and Myrtle has MWTP 2 = 40 2Q. If the marginal cost of the good is MC = 4Q, then, at the optimal quantity, the Fair price for each to pay is $24 (half the MC) which is equal to both Skippy and Myrtle s marginal willingness to pay for that many units. ANS: Add MWTP (vertically) Total MWTP = 120 6Q = MC =4Q Q* = 12 and MC(12) = 48 Skippy s MWTP for 12 = 32 Myrtle s MWTP for 12 = 16. FALSE 1 of 7

2 6) Suppose a chemical factory has MAC = 12 E and a laundry has MD = 2E. If the laundry initially has the right to zero pollution, then at the socially efficient level of emissions, a Lump-sum payment by the chemical factory that is greater than $16 and less than $40 will potentially make both parties better off. ANS: 12 E = 2E therefore E* = 4. At optimum total damages = (1/2)*MD(4)*(4) = (1/2)(8)(4) = 16 For Chemical Factory: TAC at E = 0 is (½)(12)(12) = 72 TAC at E = 4 is ½ (8)(8) = 32 Savings in TAC is 40 TRUE 7) Suppose 10 people each have the following demand for clean drinking water: Q = P (Litres Per Year). If they spend $1500 in the first year (t = 0) on a purifier they can have clean drinking water for the next three years at a price of P = 2. If the interest rate is 10% then a Benefit/Cost calculation says that this project has a net benefit of negative eight hundred dollars ( $800) 8) A regulator is uncertain about position of the MAC curve but knows that the MD curve is steep. In this case an emissions standard is preferred to an emissions tax. TRUE 2 of 7

3 PART III: Problems 10 marks each Problem 1: Suppose there are two firms with different MAC s. Firm 1: MAC 1 = 100 E 1 Firm 2: MAC 2 = E 2 Note that without any regulation, both firms will produce 100 units of emissions each (total = 200). The government wishes to reduce total emissions to 100. a) Suppose the government imposes a uniform standard equal to 50 units per firm. Calculate the total abatement cost to each firm and graph your result. Does this meet the equi-marginal principle. Firm 1: TAC= 50x50x0.5 = 1250 (area acg) MAC = 50 Firm 2: TAC = 50x75x0.5 = 1875 (area abg) MAC = 75 Total TAC = 3125 b) Now suppose the government wants to use an emissions tax. Find the tax rate that will reduce the total emissions by 100. What will be the emissions of each firm and what will be their total abatement cost under this system? Is abatement costs the firms only cost under this system? (Hint: find the aggregate MAC to find the optimal tax) Add E 1 + E 2 = (100 MAC) + (100 2/3MAC) = 200-5/3MAC Or MAC = 120 3/5E t set E t = 100 and MAC = 60 = tax Firm 1: E = 40 TAC = 1800 Firm 2: E = 60 TAC = 1200 Total TAC = 3000 (cheaper than standard) c) Which system would they prefer? Demonstrate your choice with numbers (costs). Even though it is more efficient with the tax, firm 1 pays $2400 in taxes plus $1800 in abatement. Firm 2 pays $3600 in taxes plus $1200 in abatement. They prefer Standards. 3 of 7

4 d) Suppose each firm was allocated 50 permits. What would be the amount traded and what would be the NET private cost for each FIRM? Permit Trading would be the same outcome as the TAX. Firm 1 would have E1 = 40 (Abate 60) and sell 10 permits Firm 2 would have E2 = 60 (Abate 40) and buy 10 permits Permits would sell for 60 Private Net costs = TAC +/- permit revenue/cost Firm 1: TAC = 1800 Permit Revenue = 600 Net cost = 1200 Firm 2: TAC = 1200 Permit costs = 600, Net cost = of 7

5 Problem 2: Suppose that the MD = 5E and with its current technology, the firm s MAC is given by MAC 1 = 200 5E. a) Determine the socially optimal level of emissions E E = 5E, therefore E = 20 b) Determine the emissions tax that would achieve the socially optimal level of emissions. Tax, t = MAC = 200-5E = 200 5(20) = 100 Now suppose the firm can adopt a new technology that changes is MAC to New MAC 2 = 160 4E Assuming no change to standard or tax rate after the change in technology, Calculate change in costs for the firm from adopting the new technology when: c) The government uses an emissions standard equal to your answer in (a) above If Standard set at E = 20, Old Technology has a TAC = $1000. New Technology has MAC = 80 and a TAC = 800. Savings from switching is $200. d) The government uses an emissions tax equal to your answer in (b) (Assume no change to standard or tax rate after the change in technology) With $100 tax Old: MAC1 = 200 5E = 100 tax E = 20 New: MAC2 = 160 4E = 100 tax E = 15 Tech 1 (old) Tech 2 (new) TAC 100 x 20 x (1/2) = x 100 x (1/2) = 1250 TAX Bill 100 x 20 = x 15 = 1500 $3000 $2750 Savings from switching is $250 5 of 7

6 Now suppose the government adjusts the standard and/or the tax such that MD = New MAC. Calculate the change in total costs for the firm from adopting the new technology when: e) The government adjusts the standard, and f) The government adjusts the tax rate Under NEW technology: MAC2 = MD 160 4E = 5E E = 17.8 and MAC = 88.9 With a standard equal to 17.8 TAC = ( )(88.9)*(1/2) = Savings = = 13.2 Under Tax rate of t = 88.9, E = 17.8 Tax bill = (88.9)(17.8) = And TAC = TAC + Taxbill = Savings = = of 7

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