‭ hrenya Jain‬

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‭73756173‬

‭ECON 371 Problem Set 3‬

‭True/False‬

‭1. A free rider is an agent who contributes to a public good but does not benefit from it.‬‭True‬

2‭ . Emission taxes and permit trading are market-based policies, where one focuses on‬
‭prices and the other on quantity.‬‭True‬

3‭ . Under emission rate trading, a buyer pays the seller to reduce the seller’s emissions‬
‭rate below some base rate so that the buyer can have a higher emissions rate.‬‭False‬

4‭ . Offset buyers are always voluntary individuals or firms who choose to purchase offsets‬
‭without a statutory requirement.‬‭True‬

5‭ . The “independence property” means that the initial allocation does not matter for the‬
‭cost-effectiveness of a cap-and-trade market.‬‭True‬

6‭ . If the MAC is known with certainty but the MAB is uncertain, the total emissions and‬
‭DWL loss are the same whether the regulator uses a price or a quantity instrument.‬‭False‬

7‭ . The social cost of carbon is used to help evaluate the benefits of policies that would‬
‭reduce emissions.‬‭True‬

‭8. Climate change mitigation is an excludable good.‬‭False‬

9‭ . The Environmental Kuznets Curve hypothesis argues that as countries become richer,‬
‭they always produce more environmental degradation.‬‭False‬

‭Multiple Choice‬

1‭ . A prescriptive regulation (or command-and-control) approach to environmental‬

‭policy most often uses‬‭standards‬‭in order to bring‬‭about socially desirable‬
‭behaviour. (CHOOSE ONE)‬

a‭ . subsidies‬
‭b. standards‬
c‭ . advertising campaigns‬
‭d. Pigouvian taxes‬

‭2. Ambient standards‬‭a, e‬‭. (CHOOSE ALL THAT APPLY)‬

a‭ . cannot be enforced directly.‬

‭b. will be met when setting a set of emission standards.‬
‭c. dictates what types of equipment polluters may use.‬
‭d. achieve better results than technology standards.‬
‭e. are normally expressed in terms of average concentration levels.‬

3‭ . If an emission standard is set above the socially efficient level of emissions, the‬
‭result will be a socially inefficient level of pollution, and‬‭marginal damages‬‭will be greater‬
‭than‬‭marginal abatement costs‬‭. (CHOOSE ONE)‬

a‭ . total damages; total abatement costs.‬

‭b. total abatement costs; total damages.‬
‭c. marginal damages; marginal abatement costs‬
‭d. marginal abatement costs; marginal damages‬

4‭ . Suppose country A emits PM2.5, causing damages in both country A (MDa > 0)‬
‭and neighboring country B (MDb > 0). Reducing emissions is costly for country A,‬
‭with those costs given by MACa. (B does not produce emissions.) Prior to the‬
‭agreement, country A chooses a level of emissions that is socially efficient‬
‭considering only its own damages and costs of abatement.‬
‭Then, the two countries reach an agreement in which B agrees to a side payment‬
‭to country A, while in return A agrees to emit the efficient level of emissions from‬
‭the perspective of both countries (that is, the level that results in the lowest total‬
‭costs across both countries)‬
‭At the agreed upon level of emissions, which of the following must be the case‬
‭after the agreement is reached? (CHOOSE ALL THAT APPLY)‬
‭(Hint: it may be helpful to draw a picture.)‬

a‭ . MACa < MDa‬

‭b. MACa = MDa‬
‭c. MACa > MDa‬
‭d. MACa < MDb‬
‭e. MACa = MDb‬
‭f. MACa > MDb‬
5‭ . Total emissions from polluters decrease in a CAP program if t‬‭he total number of permits‬
‭decreases‬‭.‬
‭(CHOOSE ONE)‬
‭a. the total number of permits decreases.‬
‭b. the marginal abatement cost of all polluters decreases.‬
‭c. the price of permits decreases each year.‬
‭d. the total number of permits increases.‬

‭Short questions‬

1‭ . Acid Rain Prompt (will be used for later questions):‬

‭A country plagued by acid rain is attempting to control their SO2 emissions. Each‬
‭additional unit of emissions contributes the same measure of damage, where‬
‭MD= 15. The country is subject to MAC = 6A.‬

‭a. What is the appropriate level of Pigouvian tax? ($t/ton). Explain.‬

‭ . (Refer to the acid rain prompt above.) Suppose the country discovered a new‬
b
‭technology that reduced the costs of abatement to MAC' = 3A. What is the‬
‭appropriate level of Pigouvian tax now? ($t/ton). Explain.‬

c‭ . (Refer to the acid rain prompt above.) Now suppose the country decided to‬
‭regulate this using a cap-and-trade system instead. Compute the cap required to‬
‭result in the same permit price as the Pigouvian tax level under MAC' = 3A.‬
‭Assume that firms in the country would produce 150 units of emissions total in the‬
‭absence of regulation‬

‭ nswer:‬
A
‭a.‬‭The appropriate level of Pigouvian tax can be calculated‬‭using the formula:‬
‭Pigouvian tax (t)=MAC−MD‬

‭ iven that MAC=6A and MD=15, substituting these values into the formula:‬
G
‭Pigouvian tax (t)=6A−15=6A−15‬

‭So, the appropriate level of Pigouvian tax is 6A−15.‬

‭ .‬‭With the new technology reducing the costs of abatement‬‭to MAC =3A, we can calculate the‬
b
‭new appropriate level of Pigouvian tax using the same formula:‬
‭Pigouvian tax (t)=MAC’ −MD‬
‭ ubstituting the new value of MAC' and MD into the formula:‬
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‭Pigouvian tax (t)=3A−15=3A−15‬

‭So, the appropriate level of Pigouvian tax with the new technology is 3A−15.‬

c‭ .‬‭To compute the cap required to result in the same‬‭permit price as the Pigouvian tax level under‬
‭MAC ′ =3A, we first need to find the permit price under the Pigouvian tax level.‬
‭The permit price under the Pigouvian tax can be calculated as:‬

‭ ermit price = MAC ′ −Pigouvian tax (t)‬

P
‭Substituting the values of MAC ′ and the Pigouvian tax from part b:‬
‭Permit price = 3A−(3A−15) =15‬

‭ ow, to find the cap required, we divide the total allowable emissions (150 units) by the permit‬
N
‭price:‬

‭Cap required= Total allowable emissions/ Permit price‬

‭ ap required=‬
C
‭150/15=10‬

‭ o, the cap required to result in the same permit price as the Pigouvian tax level under‬
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‭MAC ′ =3A is 10 units.‬

‭2. Global Carbon Abatement Prompt (will be used for later questions)‬

‭ uppose the world has two countries a, and b. Each generates carbon emissions.‬
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‭The marginal abatement cost curves for abatement are given for each country as‬
‭MACa = 2Aa, and MACb = 5+3Ab. Initially (pre-regulation), firm a emits 80 units of‬
‭emissions and firm b emits 60 units.‬

a‭ . Suppose that the countries agree to a cap and trade system. They agree to a cap‬
‭of 100 units of emissions in total. What is the total required abatement?‬

‭ . Assume that the countries are allowed to trade permits. What is the level of‬
b
‭abatement in the country a(𝐴∗𝑎 ) after trading has occurred and cost-effectiveness‬
‭is reached?‬

‭c. Assume that a is allocated 80 permits and b is allocated 20 permits:‬

-‭ Which country will sell permits? (Answer should just be "a" or "b", without‬
‭quotes.)‬
‭- How many permits will that country sell?‬

‭ . Continue to assume, as in the previous question, that a is allocated 80 permits and‬

d
‭b is allocated 20:‬
‭- What is the least the selling country will accept in total in return for the permits?‬
‭- What is the most the buying country will be willing to pay?‬

e‭ . Assume that the countries agree that the buying country will pay the selling country‬
‭$700 for the permits:‬
‭- What are the gains from trade (relative to the initial distribution of permits) for‬
‭country b?‬

f‭ . Now assume that the countries receive damages of MDa=34 and MDb=22 for‬
‭each unit of total emissions, respectively. At what level should the new cap be set‬
‭to achieve the social optimum?‬

‭Answer:‬

a‭ .‬‭The total required abatement is the difference‬‭between the initial total emissions and the‬
‭agreed cap:‬

‭ otal initial emissions = Emissions from country a + Emissions from country b‬

T
‭= 80 units + 60 units‬
‭= 140 units‬

‭ otal required abatement = Total initial emissions - Cap‬

T
‭= 140 units - 100 units‬
‭= 40 units‬

‭ .‬‭After trading has occurred and cost-effectiveness‬‭is reached, the level of abatement in country‬
b
‭a (A*a) can be found by comparing the marginal abatement costs (MAC) of both countries and‬
‭the total required abatement.‬

‭Total required abatement = 40 units‬

‭ ince MACa = 2Aa, and MACb = 5 + 3Ab, to reach cost-effectiveness, we equate MACa and‬
S
‭MACb:‬
‭2Aa = 5 + 3Ab‬

‭Given that firm a initially emits 80 units of emissions, we can solve for Aa:‬

2‭ (80 - Aa) = 5 + 3Aa‬

‭160 - 2Aa = 5 + 3Aa‬
‭155 = 5Aa‬
‭Aa = 31 units‬

c‭ .‬‭The country that will sell permits is country b‬‭because it has fewer emissions than the permits‬
‭it holds.‬

‭d‬‭. Given that country a is allocated 80 permits and‬‭country b is allocated 20 permits:‬

‭ he least the selling country (country b) will accept in total in return for the permits is the cost of‬
T
‭abatement it would incur if it were to emit up to the cap. This can be calculated by finding the‬
‭abatement cost for the remaining emissions after the allocation of permits.‬
‭The most the buying country (country a) will be willing to pay is the cost of abatement it would‬
‭incur to reduce its emissions to the cap level, considering its initial emissions and the‬
‭cost-effectiveness level.‬
‭e. If the buying country (country a) agrees to pay $700 for the permits, the gains from trade‬
‭(relative to the initial distribution of permits) for country b would be the difference between what‬
‭it receives from the sale of permits and the cost of abatement it would incur if it were to emit up‬
‭to the cap.‬

f‭ .‬‭To achieve the social optimum, the new cap should‬‭be set where the marginal damage (MD) of‬
‭emissions equals the marginal abatement cost (MAC) for both countries.‬

‭ or country a:‬
F
‭MDa = 34‬
‭MACa = 2Aa‬

‭ or country b:‬
F
‭MDb = 22‬
‭MACb = 5 + 3Ab‬

‭ et MDa = MACa and MDb = MACb and solve for Aa and Ab to find the optimal emissions‬
S
‭levels for both countries. Then sum up the optimal emissions for both countries to find the new‬
‭cap.‬
3‭ . Consider the market for strawberries: demand is given by MB = 100 − 5Q while‬
‭supply is given by MC = 20 + Q. (You do not need to calculate exact values for‬
‭any of the following questions, although you may find it helpful to do so.)‬

a‭ . Plot the supply and demand for strawberries. Also, label the market equilibrium‬
‭Qm and price Pm on your plot.‬

‭ . Unfortunately, agricultural runoff from the production of strawberries creates $30‬

b
‭of damages per unit. Plot the MEC on the same graph, and add a line for SMC.‬
‭Identify the social optimum Q* and P*.‬

c‭ . Suppose the government applies a tax of $20 per unit of strawberries. Draw and‬
‭label this tax as a vertical line on your plot, and label the quantity sold under‬
‭taxation QT and the prices paid by consumers PC and producers PP.‬

‭d. On your plot, draw and label the DWL when the tax is implemented.‬

‭Answer:‬

a‭ .‬‭To plot the supply and demand for strawberries,‬‭we can use the given demand and supply‬
‭functions:‬

‭ emand: MB = 100 - 5Q‬

D
‭Supply: MC = 20 + Q‬

‭At equilibrium, demand equals supply, so we set MB equal to MC:‬

‭100 - 5Q = 20 + Q‬

‭Solving for Q, we find:‬

1‭ 00 - 20 = 5Q + Q‬
‭80 = 6Q‬
‭Q = 80/6‬
‭Q = 13.33 (approximately)‬

‭ o find the equilibrium price, we substitute the value of Q into either the demand or supply‬
T
‭function. Let's use the demand function:‬
‭ = 100 - 5Q‬
P
‭P = 100 - 5(13.33)‬
‭P ≈ 33.33‬

‭ o, the equilibrium quantity (Qm) is approximately 13.33 and the equilibrium price (Pm) is‬
S
‭approximately $33.33.‬

‭ .‬‭The Marginal External Cost (MEC) due to agricultural‬‭runoff is $30 per unit. The Social‬
b
‭Marginal Cost (SMC) will be the sum of the marginal private cost (MC) and the marginal‬
‭external cost (MEC).‬

‭ MC = MC + MEC‬
S
‭= 20 + Q + 30‬
‭= 50 + Q‬

‭To find the social optimum (Q*), we equate the demand (MB) with the SMC:‬

1‭ 00 - 5Q* = 50 + Q*‬
‭150 = 6Q*‬
‭Q* ≈ 25‬

‭ o find the corresponding price (P*), we substitute the value of Q* into either the demand or‬
T
‭supply function. Let's use the demand function:‬

‭ * = 100 - 5(25)‬
P
‭P* = 100 - 125‬
‭P* = -25‬

‭ o, the social optimum quantity (Q*) is approximately 25 and the corresponding price (P*) is‬
S
‭-$25. However, since negative prices are not meaningful in this context, we can ignore the‬
‭negative sign and interpret it as a significant price increase or market intervention.‬

c‭ .‬‭The government applies a tax of $20 per unit of‬‭strawberries. This tax shifts the supply curve‬
‭vertically upward by the amount of the tax. So, the new supply curve becomes:‬

‭ C + Tax = 20 + Q + 20‬
M
‭= 40 + Q‬
‭The quantity sold under taxation (QT) will be determined at the intersection of the new supply‬
‭curve and the original demand curve. Prices paid by consumers (PC) and producers (PP) will‬
‭also be determined at this intersection.‬
d‭ . The deadweight loss (DWL) occurs due to the reduction in consumer and producer surplus‬
‭caused by the tax. It can be represented by the triangular area between the supply and demand‬
‭curves, starting from the new equilibrium quantity (QT) and price (PC), extending to the original‬
‭equilibrium quantity (Qm) and price (Pm).‬

‭Essay‬

‭ rgue for and against setting a uniform national standard for restricting the amount of‬
A
‭salinity (saltiness) in tap water across Canada. Under what circumstances might location-‬
‭specific standards be more cost-effective? Under what circumstances might a uniform‬
‭standard be better? Answer in 100 words or fewer.‬

‭Answer:‬

‭ rguing for a uniform national standard: A uniform standard ensures consistent water quality‬
A
‭nationwide, simplifying regulatory compliance and providing equal protection to all citizens. It‬
‭promotes public health and confidence in tap water regardless of location, fostering trust in‬
‭government oversight.‬

‭ rguing against a uniform national standard: Canada's diverse geography and water sources may‬
A
‭require tailored approaches to address local salinity variations effectively. Location-specific‬
s‭ tandards can account for regional differences in water sources, treatment technologies, and‬
‭environmental conditions, potentially reducing compliance costs and optimizing resource‬
‭allocation.‬