Power stations emit sulfur dioxide as a waste product. This generates a cost to

Question

Power stations emit sulfur dioxide as a waste product. This generates a cost to society that is not 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. 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 $ per ton of sulfur dioxide emitted will achieve the desired level of pollution. 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 $. The previous analysis hinges on the government having good information regarding either the demand for pollution permits or the optimal level of pollution (or both). Given that the appropriate policy (tradable permits or corrective taxes) can depend on the available information and the policy goal, consider the following scenario. An environmental study conducted in a particular city suggests that if a chemical plant emits more than 100 million tons of chemicals each year, the water supply will become contaminated beyond the point where filtration techniques can make it safe for drinking. If this is all the information the government has, which solution to reduce pollution is appropriate? Check all that apply. Corrective taxes Tradable permits

Explanation / Answer

The government has fixed socially optimal quantity of sulfur dioxide emission at 350 millions tons per day.To limit emission at this level price charged must be $27 whereas the current price of pollution right is $9.Therefore a tax of ($27-$9)$18 must be imposed to limit emission to the desired level.

(a)

A tax of $18 per ton of sulfur dioxide emitted will achieve the desired level of pollution.

(b)

Given the quantity of permits the price for each permit in the market for pollution right will be $27

This can be seen from the given demand curve when quantity is 350 million ton per day price of pollution right is $27.

(c)

If government knows that a chemical plant emits more than 100 million tons of chemical each year then the best way to reduce pollution is to auction Tradable permits because through permit it can be sure of the pollution that will be generated whereas if it decides to impose tax it cannot be sure about the level of pollution that will be generated.

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