Environmental Economics and Policy – V625

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. Again, assuming that the MSE curve is correct, if the government were going to induce abatement of air toxics through an emissions fee, what would be the optimal fee? How much annual revenue would the government expect to collect? Fee = $17.4/ton Ann Rev = $125.3 c. If the government were going to induce abatement through a marketable permit system, how many permits would it issue? What would you expect the market price of the permits to be? Total of permits sum to 7.2 tons (e.g., 7.2 one-ton permits or 72 tenth-ton permits). Expected price $17.4/ton. Now assume that the government has estimated that the true MS curve could fall anywhere in the range of MSE + 3, i.e., between MSL and MSH. d. If the government uses the price-based (fee) approach, and the true MS turns out to be MSL, how much will firms emit and what is the associated deadweight loss compared to the optimal level of emissions (i.e., optimal given that true marginal savings are described by MSL)? Outline that area on the graph and label it with a (d). If the government uses the price-based approach: P = $17.4/ton. The optimal level of emissions for MCL is 6 tons at MCL = $14.4/ton. Firms will actually only emit 1.2 tons Result: over-abatement. To derive: Insert P = 17.4 in the MCL, e = (18-17.4)/0.5 = 1.2 => emissions will be 1.2 tons DWL = area d = 0.5 (17.4-5.4)(6-1.2) = 28.8 e. If the government uses the quantity-based approach, and the true MS turns out to be MSL, how much will firms emit and what is the associated deadweight loss compared to the optimal level of emissions? Outline that area on the graph and label it with an (e). If the government uses the Q-based approach, it will issue 7.2 tons of allowances. From part (a): optimal emissions = 6 tons DWL = area e = 0.5 (17.4-14.4)(7.2-6) = 1.8 2
f. What do your answers to questions (d) and (e) tell you about which instrument is most appropriate for this Death Valley application. What is the general (Weitzman) proposition we discussed in class for instrument choice under uncertainty and is it consistent with your prescription? Given the uncertainty, the quantity-based approach is more appropriate. The general principle said that when the MD curve is flat (shallow slope) relative to the MS curve, then a price-based approach is appropriate. When the MD curve is steep relative to the MS curve (as in the case), then the quantity-based approach is preferred (i.e., minimizes expected DWL). 2. (10) Suppose you are the head of the Illiana State Environmental Protection Service. You have been charged with implementing the state water quality protection program. The primary polluters in your state are pulp and paper mills. The technology for water pollution abatement at the mills is pretty uniform across the industry. Given current regulatory standards, the marginal cost of abatement when firms are in compliance is $12,000/ton. Your primary mechanism for inducing compliance with standards is fines for exceeding the standard, where violations are detected by a team of inspectors. Bowing to industry pressure, the state legislature has limited the amount of a fine to $100,000 per ton in excess of the permitted amount. Suppose you are designing your monitoring program. To assure that firms have an incentive to abate at the proper level, what goal are you going to set regarding the probability that a violation will be detected? Provide a numeric response. MC = $12,000/ton. We want the expected fine for noncompliance, E(fine), to be at least as large as the MC. E(fine) = pr(detection) * fine for detection > $12,000/ton = pr(detection) * $100,000/ton > $12,000/ton => pr(detection) > 0.12 ore 12% 3. (10) You are evaluating a project to save the precariously endangered polka dotted egret. The plan in front of you is given a 50-50 chance of working. The cost of the plan is $5 million. If it succeeds, the benefit of saving the polka dotted egret is estimated to be $9million. If it fails, there are no benefits. Does this project pass the cost-benefit test? Show your analysis. E(Benefits) = 0.5 ($9.0M) + 0.5 ($0) = $4.5M Costs = $5M E(Net benefits) = $4.5M - $5.0M = -0.5M => does not pass the CBA test. 4. (10) Gasoline is generally considered a private market good. However, as we all know, the combustion of gasoline can have various negative environmental effects on global warming, acid rain, particulate levels, etc. Suppose the 3
Page 1: Environmental Economics and Policy
Page 5: Tax revenue = $9.8/gal * 19,600 gal

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