The Economics of Environmental Protection

The Economics of Environmental Protection
The Economics of Environmental Protection
Question 2
a) social; private
b) tax; internalized
c) marginal external cost; allocatively efficient
Question 4
a) See the diagram below. If each unit of lumber produced also generates $10 of damage to
the environment, the social marginal cost of production is $10 greater than the private
marginal cost (at each level of output). We draw the social marginal cost curve and label it
MCS. The competitive equilibrium (in the absence of any pollution regulation) is price p
and quantity QC
b) The allocatively efficient level of lumber output is that level where the marginal cost to
society of an extra unit of lumber equals the marginal benefit to society of an extra unit.
Since we have not output is Q*. As with all negative externalities, the free market ends up
producing too much of the product in question, Q* < QC
c) If lumber producers are required to pay a $10 tax per unit of lumber produced, then their
private marginal costs rise by exactly $10, making MCP the same as MCS. In this case, the
pollution externality has been fully internalized because firms are required to pay the full
social cost of their production. The competitive equilibrium with such pollution taxes will
be price p* and quantity Q*. This is allocatively efficient.
d) The vertical distance between the two MC curves is exactly $10. But p* is less than $10
greater than p
The Economics of Environmental Protection
. This is because there is some slope to the demand curve, and so some of
the reduction in supply (due to the tax) ends up as higher prices but some ends up as
reduced equilibrium quantity. The less elastic is the demand curve, the more the price
would increase from its pre-tax level. Only in the case of perfectly inelastic demand (a
vertical demand curve), would p* be exactly $10 greater than p
The Economics of Environmental Protection
Question 6
a) For abating Q3 units of pollution, the marginal cost for Softies Inc. is $30; the marginal
cost for Cuddlies Inc. is $50.
b) Yes. Since MC of abatement is currently not equated across the two firms, the given
amount of pollution abatement could be achieved at a lower total cost. For example, Softies
could abate one additional unit and Cuddlies could abate one fewer unit and the total cost
would fall. This redistribution could continue until marginal cost is equated across the two
firms. (Note that if units of abatement are indivisible, we may not be able to exactly equate
MC across the two firms, but we definitely could if units are perfectly divisible.)
c) A tax of $40 per unit of emissions is each firm’s “marginal benefit” of abatement
because for each unit of pollution abated the firm avoids having to pay $40.
d) With a per-unit emissions tax of $40, each firm will abate until the marginal cost of
abatement equals $40. For Softies Inc., the diagram shows that the amount of abatement
will be approximately half-way between Q4 and Q5. For Cuddlies Inc. the amount of
abatement is approximately three-quarters of the way between Q1 and Q2. Thus we see that
if both firms face the same per-unit emissions tax, the firm that can abate at lower cost will
end up abating more, and the high-cost-abatement firm ends up abating less.
e) No. Since the marginal cost of abatement is equated across the two firms, there is no way
to reduce the total cost of the given amount of pollution abatement.
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