Lesson 3

Question 1

summary about externalities

Answer 1

• arise when choices of some affect others
• related to a lack of property righsts
• if there is one, there is a loss of welfare (production smaller than optimal (+) or larger (-)
• can be solved with internalization, private or public

Question 2

How does pigouvian tax work?

Answer 2

= tax imposed on each unit of a good/activity that generates negative externality, set equal to the marginal external damage at the social optimal level of production (MSC=MPC+MD),
- however, the slope is linear to the MPC, but then just on a higher level (so, that is equal on each level after it is set at equilibrium)

Question 3

Meaning pigouvian subsidiy

Answer 3

= an alternative to a Pigouvian tax: instead of taxing pollution, the government pays the producer to reduce output
- Firm is paid a subsidy equal to MD at Q* for each unit it reduces from Q₁ to Q*

• works exactly like the tax did (same graph)

Question 3

Why are pigouvian subsidies not used often?

Answer 3

• require resources to implement them
• require some barrier to enter into the market, otherwise producers enter just to take advantage

Question 4

meaning emissions

Answer 4

= tax directly on the amount of pollution emitted, rather than on the quantity of a good produced.
It creates a price for emissions, encouraging firms to reduce pollution in the most cost-effective way (part of pigouivian tax)

in graph: set fee (f) based on equilibrium of MC and MSB

Question 4

advantages of emission fees over pigouvian tax

Answer 4

1. reduction in emission can come from multiple things (reduction of quantity, new technologies, pollution filter, change in inputs)
2. when there are multiple polluters, it also can account for costs of reducing emission across companies –> emission fee will naturally result in most cost effective reduction

Question 4

2 different companies with emission fees, what will happen?

Answer 4

1. restrict costs to be equal for both companies
2. find option were the total is desire
3. set emissions fee there

–> companies will reduce their emissions to the equilibrium of Mc and f –> companies with a lot of costs will lower more than companies with less (for one more worthwhile than for others)

Question 6

Cap-and-trade

Answer 6

= similar to the idea of emissions fees, only now instead of using pricing, we use quantity.
- We want to get the cost effective reduction, at any allocation of permits

–> set permits at 80 –> let companies trade:
- company 1 sells if price of permits is higher than costs per unit
- company 2 buys if permits are lower than saving unit
–> MC1 < P < MC2 –> trade happens if MC1 = MC2

Question 7

emissions fees vs. cap-and-trade, other considerations why to choose which:

Answer 7

1. inflation
   - cap-and-trade: uses real prices (based on quantity)
   - emissions fees: has to update with inflation, otherwise not same reduction effect (getting cheaper)
2. cost changes
   - cap-and-trade: marginal costs of pollution can change –> pollution reduction stays the same, but companies have more costs (allowed to make 20 products, more inkoopkosten, evenveel producten dus evenveel uitstoot)
   - emissions fees: pollution reduced will adjust (equilibrium set at MC, which changes)
3. uncertainty in measurements
   - depends on elasticity of MSB curve (how quickly benefits fall with each unit of pollution reduction, which depends on externality

–> cap-and-trade always stays steady, but without cost control
–> emissions fee vary in reduction, because they are sensitive to changes

Question 9

Inelastic (steep) vs. Elastic case (straight) MSB

Answer 9

INELASTIC
Equilibrium guessed not far away from actual equilibrium
–> set fee to Eguessed but end up at Equilibrium fee (opposite site)

conclusion: inelastic MSB, cap-and-trade is preferred (more efficient, but hits producers harder)

ELASTIC
Eguessed further away from actual Eactual
–> lots of extra social benefits, but high costs for producers

conclusion elastic MSC, emissions fees is preferred (more efficient, but falls short on externality reduction)

Question 9

2 types of regulations

Answer 9

1. technology standard
2. performance standard

Question 9

meaning technology standard

Answer 9

=requires companies to install pollution reducing device/undertake pollution-reducing behavior

problems: no room for other type of innovations & have to pay costs for them, even it it is still worth it for them to pollute

Question 9

meaning performance standards

Answer 9

=sets pollution goals/requirements that are the same for all (in a group)

problem: dienst allow for reallocation of reduction to lower costs

Question 10

Why consider command and control over incentive based

Answer 10

1. monitoring ease/cost
   - emissions fees: where to set the fee
   - cap and trade: may not be clear what even to create permits for

–> easier to monitor is something is installed yes or no

2. distributional reasons
   - incentive based: shift reduction allocation from high to low cost companies –> pollution will gather in “hot spots”
   - this is cost-effective, but it hurts some more than others

–> technology/performance sta cards will spread costs on those harmed more evenly