Suppose the marginal external cost of emissions of a certain substance is equal to $16. Furthermore assume that there are two sources of these emissions. The unregulated emissions (Ei), total cost of abatement (TCAi), and marginal cost of abatement (MCAi) for the two sources are given below:
Source 1: E1 = 20 TCA1 = (A1)2 MCA1 = 2A1
Source 2: E1 = 20 TCA2 = ½(A2)2 MCA2 = A2
(a) Explain why the marginal benefit to emissions abatement (MBA) is equal to $16. What is the efficient level of abatement for each source? Illustrate in a diagram. [6]
A principle in economics is that the marginal cost or marginal abatement and marginal benefit needs to be equal. This means that the cost incurred by society (in forms of environmental impact and economic impact) need to be equal to the marginal benefit incurred by the consumer. The re
(b) How would each firm respond to a per unit tax on emissions equal to $t. That is, can you express abatement as a function of the tax? What is the efficient tax? Given the efficient tax, what is the total cost to each source (abatement costs plus taxes paid)? [6]
(c) Suppose instead of the tax, a regulator assigns to each source non-transferable permits for 8 units of emissions, how many units of abatement will each firm undertake? Explain, calculate, and illustrate the inefficiency of this policy. [8]
(d) Now suppose that the regulator assigns to each firm tradable permits for 8 units of emissions. What would be the equilibrium price of a permit after trade has taken place? What would be the allocation of abatement?