Week 5- Government Intervention to Correct Market Failure

Question 1

draw: socially efficient level of environmental quality (MAC+MDF)

Answer 1

• Marginal abatement cost curve (downward sloping). continues to zero and high pollution because there is so many damages that the site is better left degraded
• Marginal damages curve (upward sloping). e.g sediment pollution in river from logging makes it unsafe to swim in and biodiversity decreases.

Question 2

Draw: Social costs when pollution is greater than optimal

Answer 2

• deadweight loss on right hand side of graph

- costs society more in form of environmental degradation than benefits of greater pollution (production).

Question 3

Draw: Social costs when pollution is lower than optimal

Answer 3

• costs society more to clean up then the benefits of lower pollution.
• deadweight loss on left

Question 4

Draw: optimal level of pollution with technological innovation

Answer 4

• MAC (abatement cost) curve lowered.

- new level of optimal pollution as it costs less for society to clean up or less damages from production

Question 5

Pigouvian approach to market failure

Answer 5

• use taxes to remove divergence between MSC and MPC, and MSB and MPB

Question 6

Pigouvian tax on timber production (negative externality)

Answer 6

• increase MPC of production to where MSC intersects MSB curve with tax
• tax to remove deadweight loss from over harvesting

Question 7

Pigouvian approach on positive externalities

Answer 7

subsides

Question 8

Problem with pigouvian approach of levying taxes on production of timber when externality is water quality

Answer 8

doesn’t encourage development of technology that minimises impacts on water quality

Question 9

solution to pigouvian tax problem

Answer 9

• externality should be taxed (e.g sediment levels in water, not volume of timber harvested

Question 10

public good eg

Answer 10

air, national defence, knowledge

Question 11

why market failure for public goods

Answer 11

private market will not supply the good since no one would pay for it because they cannot be excluded from benefits (“free rider”)

Question 12

externalities associated with public goods are…

Answer 12

positive

Question 13

the social value of public goods are substantially greater than the private value because

Answer 13

because benefits are non-rivalrous and non-excludable

Question 14

free market quntity of public good is ___ than sociall efficient quantity

Answer 14

less… because private producers cannot avoid free riders.

Question 15

socially efficient price

Answer 15

MSB=MSC

Question 16

Coase’s approach to correction of market externalities

Answer 16

• gov intervention not neccesary
• clearly defined property rights is all that is necessary
• market for externality will automatically develop
• bargaining between generator and victims of externality will lead to socially efficient level of an externality.
• Whoever has the property right will receive payments. The party without the property rights will pay a bribe to the party with the property rights

Question 17

Coase: initial distribution of property rights ____ ___ affect reaching the efficient level of the externality

Answer 17

DOES NOT

Question 18

Coase: The initial distribution of property rights ___ affect costs and benefits for polluters and people affected by the externality

Answer 18

DOES

Question 19

Conditions for Coases theorm to hold:

Answer 19

(1) absence of transaction costs;
(2) well defined property rights;
(3) perfect competition in the abatement market;
(4) no income effects;
(5) no effects on entry or exit of firms; and
(6) no free riders.

Question 20

endowment effect

Answer 20

people more willing to pay for an improvment in envm quality than they are to recieve compensation for a reduction as they are happy where they are

Question 21

Public policy and instituional appraoches to correct market failure

Answer 21

• Moral suasion (convince public + > -)
• direct public production (bioversity conservation)
• Command and control
• Property rights and creating markets
• Economic incentives (tax and subsidies + Marketable pollution permits)

Question 22

Command and control

Answer 22

• government restrictions on inputs and outputs
• e.g never exceed a level for some air pollutant
• not always a set-quanity e.g technology standards - seat belts in cars

Question 23

does command and control provide abatement incentives (beyond standards)?

Answer 23

no

Question 24

For command and control policies to allocate pollution abatement efficiently between firms:

Answer 24

• frims must have identical MAC or

- gov know MAC of each polluter

Question 25

MPPs VS CandC

Answer 25

MPPs minimise total abatement costs and provide incentives while achieving target level of pollution with a high degree of certainty

Question 26

MPP conditions

Answer 26

- after initial allocation of permits, polluters are free to trade - polluters with high MAC will have incentive to buy pollution permits - polluter with low MAC will have incentives to sell pollution permits Therefore. MACs will equate

Question 27

Coase assumption 1: absence of transaction rights

Answer 27

- increasing lines (difficulty) of communication with increasing participants - could go through courts

Question 28

Coase assumption 2: well-defined property rights

Answer 28

- if rights are not specified by legislation, regulation or custom, making bargaining difficult - litigation to solve

Question 29

If MDF is underestimated when setting a tax...

Answer 29

- The MAC should be up to left - crosses MAC at higher cost level - efficient tax level is higher - efficient level of pollusion is lower

Question 30

Why pigouvian tax's and tradeable pollution permit will result in more efficient pollution reduction than CandC

Answer 30

- CandC typically require firms to reduce pollution by the same amount. Given costs of abating pollution varies between firms, compliance costs will be low for some and prohibitive for others

Question 31

For CandC to incentivise for firms with low abatement costs to reduce more and not target firms with high abatement costs for large levels of emissions reduction

Answer 31

-GOV would need to know MAC of each firm.

Question 32

draw CandC: 3 diagrams, 2 firms with high and low emission abatement 50% reduction

Answer 32

- firm 1 emits 10 units unregulated (less steep curve) - firm 2 emits 6 unregulated (steep curve) - both required 50% reduction so firm 1 pays less than firm 2

Question 33

1 situation where CandC can be more efficient than tax

Answer 33

- Agggregate MAC not known for society, and so if tax is set too high (e.i industry will collapse) or low (poor health outcomes) socially inefficient outcomes will result. - CandC can achieve target with more certainty, than waiting to see the outcome of a tax if situation is dire.

Question 34

Pigouvian tax incentives

Answer 34

- For firms have less units of pollution to pay tax on if they undertake greater emissions reductions

Question 35

MPP tax incentives

Answer 35

- firms can buy less PP if they voluntarily abate pollution.

Question 36

Pigou+MPP meeting efficient target

Answer 36

- frims with low abatement have finacial incentives to reduce emission more than high abatement cost firms - firms with high abatement costs are better off paying per unit of emission tax or buying PP.

Question 37

CandC does not promote pollution reduction technology because...

Answer 37

firms have no incentive to cut emissions below the regulated target- reducing emissions further will not reduce costs to the firm.

Question 38

economic incentives does promote pollution reduction technology because...

Answer 38

tax and MPP will invest in new abatement tech that is less than per unit of emission tax.