Homework 8 Answer Key

3) Acid rain is a problem in Scandinavia. Electricity-generating plants burn coal and

emit sulfur dioxide. That sulfur dioxide is converted to sulfates, which travel long
distances and are washed out of the air as acidic rain, particularly affecting Swedish
lakes. Assume that power plants in England and Denmark are the primary culprits. Also
assume that in a year one tonne of sulfur emitted in England generates deposition on
Sweden of 1 gram of sulfate deposition in Sweden and one tonne of sulfur from Denmark
generates 3 grams of sulfate deposition in Sweden. Damage from acid rain is
approximately 1 pence per gram of sulfates deposited. If q is the reduction in annual
sulfur emissions (in tonnes) from uncontrolled levels, the marginal cost of controlling
sulfur emissions is ₤q for Denmark and ₤2q. [1₤= 100p].

a) Write the damage function, giving damages as a function of total sulfates deposited.
(12 points)

D = 1S (in pences, where S = grams of sulfates deposited)

b) Write the transfer coefficients for England and Denmark. (12 points)

Transfer coefficient for England = 1

Transfer coefficient for Denmark = 3
S = 1eE + 3eD

c) First ignore the effects of pollution on Sweden and suppose we simply want to reduce
emissions by 12 tonnes. How much of that reduction should come from Denmark, on the
basis of cost efficiency? (12 points)

We know that we cost effectively allocate abatement when the marginal abatement costs
are equated so:
MCD = 1qD = 2qE = MCE

And we know total abatement = 12, so qD + qE = 12

From the equimarginal principle, we see that qD = 2qE , so we can plug this into the total
abatement equation
qD + qE = 2qE + qE = 12
3qE = 12
qE = 4
qD = 12 − 4 = 8

Since Denmark has lower marginal abatement costs, Denmark should undertake more
abatement than England.

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 d) Now suppose we want to reduce emissions by 12 tonnes but we want to do it in a way
that takes into account effects on pollution in Sweden. Although this might not be the
right about of pollution reduction, balancing the marginal cost of controlling pollution in
Sweden from the 2 source countries would require how much of an emission reduction in
Denmark? (13 points)

Now we still use the equimarginal principle, but it is in terms of ambient concentrations
instead of emissions. To do this, we scale the marginal abatement costs by the transfer
coefficients.

MCD qD 2qE MCE

= = =
aD 3 1 aE

And it is still that case that: qD + qE = 12

From the equimarginal principle, qD = 6qE

qD + qE = 6qE + qE = 12
7 qE = 12
12
qE = ≈ 1.71
7
12 72
qD = 12 − = ≈ 10.29
7 7

6) Two identical firms save money from polluting. A firm’s marginal savings from
emitting an amount e are given by 10-2e. The two firms differ in their impact on ambient
pollution. Two units of emissions from firm 1 result in one unit of ambient pollution.
Firm 2 has twice the impact on the ambient environment from the same amount of
emissions.
a) What are the transfer coefficients? (16 points)
1
- X = e1 + 1e2
2
- The transfer coefficient for firm 1 is ½ and the transfer coefficient for firm 2 is 1.

b) If firm 1 is given 2 emission permits and firm 2 is given 4 emissions permits and they
are allowed to trade, how many permits will each firm end up with and what will be the
price? (16 points)

We know that we end up where MS1 = MS 2 .

MS1 = 10 − 2e1 = 10 − 2e2 = MS2
e1 = e2

Since there are 6 permits in total,

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 e1 + e2 = 6
e2 = 6 − e1
e1 = 6 − e1
e1* = 3 = e*2
P = MS1 = MS2 = 10 − 2(3) = 4
e1*=3

10
MS1
MS2

P=4

e1=2 e1*=3
e2=4 e2*=3

c) If instead, each firm is given 2 ambient pollution permits and trading takes place, how
much will each firm end up emitting and what will be the permit price? (17 points)

We know we will end up where:

MS1 10 − 2e1 10 − 2e2 MS2
= = = =P
a1 1 1 a2
2
20 − 4e1 = 10 − 2e2
−4e1 = −10 − 2e2
5 1
e1 = + e2
2 2

We have 4 ambient permits which implies:

1
X = 4 = e1 + e2
2
1
e2 = 4 − e1
2

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 5 1 1 
e1 = +  4 − e1 
2 2 2 
5 1
e1 = + 2 − e1
2 4
5 9
e1 =
4 2
18
e1* =
5
1  18  9 11
e2* = 4 −   = 4 − =
2 5  5 5
MS1 MS2  11  50 − 22 28
P= = = 10 − 2   = =
a1 a2 5 5 5

MS 2
MS1
a2
a1

P=28/5

e1*=18/5
e2*=11/5

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