7. Correcting for negative externalities Taxes versus tradablepermits Power stat

Question

7. Correcting for negative externalities Taxes versus tradablepermits Power stations emit sulfur dioxide as a waste product. This generates a cost to society that is noft paid for by the firm; therefore, pollution is a negative externality of power production. Suppose the U.S. government wants to correct this market failure by getting firms to internalize the cost of pollution. To do this, the government can charge firms for pollution rights (the right to emit a given quantity of sulfur dioxide). The following graph shows the daily demand for pollution rights Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly Graph Input Tool Daily Demand for Pollution Rights Price 90 81 72 63 54 45 36 27 Dollars per Quantity Demanded (Millions of tons) 450 0 50 100 150 200 250 300 350 400 450 500 QUANTITY (Milions of tons) Suppose the government has determined that the socially optimal quantity of sulfur dioxide emissions is 350 million tons per day One way governments can charge firms for pollution rights is by imposing a per-unit tax on emissions. A tax (or price in this case) of $ the desired level of pollution per ton of sulfur dioxide emitted will achieve Now suppose the U.S. government does not know the demand curve for pollution and, therefore, cannot determine the optimal tax to achieve the desired level of pollution. Instead, it auctions off tradable pollution permits. Each permit entitles its owner to emit one ton of sulfur dioxide per day. To achieve the socially optimal quantity of pollution, the government auctions off 350 million pollution permits. Given this quantity of permits, the price for each permit in the market for pollution rights will be $

Explanation / Answer

Answer:

It is a problem of negative externality.Powrer stations are emmiting Sulpher Dioxide as waste product. It is polluting the air. In order to carry out power production Power station requires the right to poluute. Government can give this right in two ways-

1. By imposing a cost on the power plant which will be spent to remove it and clean the air. Usually it is recovered in the form of tax.

2. Alternatively it can sale permits for pollution right. Power plant will buy the required units of permit to pollute the air.

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As per diagram green line indicates a $9 price per ton of pollution right. At this price power plants in total is demanding 450 million tons of pollutionright.

Now government has decided socially optimal pollution right should be 350 million ton in a year. Thus supply quantity of pollution right has been reduced. It will raise equilibrium point above. Now more price will be charged to maitain equilibrium demand and supply of pollution right. It is $27 per million ton. Present price is $9. So government has to impose tax of $27-$9=$18 per million ton.

Answer: A tax of $18 per ton of Sulfer DiOxide emmited will achieve the desired level of pollution.

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If government has no demand curve of pollution. So instead of imposing tax it has decided to sale permit of pollution. Total 350 unit permits will be sold. Price per permit should be adequate to recover marginal abatement cost of pollution. It is $27 per million of pollution.

Answer: So market price of an unit of permit is $27

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Now environmental study has reported that emission of carbon dioxide of 80 million ton or more will cotaminate water. So no firm will be allowed to pollute more than this quantity. Under this situation tradeable permit will be more effective. when tax is imposed. there will be a tendency for many firm to pay tax and emit more than 80 unit carbon., asthey may not be awrare of this restriction. But if permits are issued they are always careful not to cross the permitted quota. So result will be more effective.

It will also give flexiility to a firm. If they emit less polllution then they will buy less quantity of permits. If they have surplus permit in their hand, it can be sold to other. Also under imperfect information about the actual requirement it is the best solution.

Answer: Apply quota system.

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