Cap-and-trade
Answer the following questions (taken from Tietenberg and Lewis, Environmental & Natural Resource Economics, 2012, p.392) and the follow-up questions (c) and (d) below. Note that "allowances" is just another name for pollution permits.
In a region that must reduce emissions, three polluters currently emit 30 units of emissions. The three firms have the following marginal abatement cost functions that describe how marginal costs vary with the amount of emissions each firm reduces.
|
Firm
Emissions
Reduction
|
Firm 1
Marginal
cost
|
Firm 2
Marginal
Cost
|
Firm 3
Marginal
Cost
|
|
1
|
$1.00
|
$1.00
|
$2.00
|
|
2
|
$1.50
|
$2.00
|
$3.00
|
|
3
|
$2.00
|
$3.00
|
$4.00
|
|
4
|
$2.50
|
$4.00
|
$5.00
|
|
5
|
$3.00
|
$5.00
|
$6.00
|
|
6
|
$3.50
|
$6.00
|
$700
|
|
7
|
$4.00
|
$700
|
$8.00
|
|
8
|
$4.50
|
$8.00
|
$9.00
|
|
9
|
$5.00
|
$9.00
|
$10.00
|
|
10
|
$5.50
|
$10.00
|
$11.00
|
Suppose this region needs to reduce emissions by 14 units and plans to do it using a form of cap-and-trade that auctions allowances off to the highest bidder.
a. How many allowances will the control authority auction off? Why?
b. Assuming no market power, how many of the allowances would each firm be expected to buy? Why?
c) At what price do you expect allowances to sell for?
d) If the government decides to implement a tax rather than a cap-and-trade system, what should be the tax rate?