1. Consider a pollutant for which the damages are well understood, but the costs
ID: 1169629 • Letter: 1
Question
1. Consider a pollutant for which the damages are well understood, but the costs of abatement are uncertain. Initial emissions in the industry are 2400 units. The Marginal Abatement Benefit function is given by:
MAB = 1500 - (0.5)*A (A = Abatement)
The regulator has attempted to estimate Marginal Abatement Costs (MAC), and come up with the following estimate:
MACe = 300 +(2.5)*A
a) To target optimal abatement via a cap-and-trade policy, at what level should the regulator set the emissions cap? What will the resulting level of abatement be?
b) To target optimal abatement via an emissions tax, at what level should the regulator set the tax?
2. In fact, after the policy (in (1)) is implemented, it turns out that the actual MAC curve is given by the following:
MACa = 100 + (1.5)*A
a) Under the emissions cap established in (1(a)),
i) what will the MAC be at the cap?
ii) how much social surplus is lost, due to an incorrect cap?
b) Under the tax established in (1(b)),
i) what will the actual quantity of emissions be? What will abatement be? ii) how much social surplus is lost, due to an incorrect tax level?
3. And the moral of the story is: _____________________________________
Explanation / Answer
1.a.
MAB = MAC
1,500 – 0.5A = 300 + 2.5A
3A = 1,200
A = 400
The required level of emission would get by putting the value of A in MAB.
MAB = 1,500 – 0.5(400) = 1,700 units (Answer)
The resulting level of abetment (A) is $400. (Answer)
1.b.
The regulator should set the tax if the emission crosses 1,700 units. (Answer)
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