Question

In the presence of uncertainty about a polluting industry’s marginal abatement cost curve, under what circumstances would an environmental regulator be likely to make a smaller error in setting a quantity constraint than an emission fee? Explain why. Feel free to use a diagram to help answer this question.

Answer 1

This is an example of negative exterrnality of production. It is clear that Marginal social cost is. more than marginal private cost.

This externality can be corrected mainly in two ways: Taxing output or taxing emission levels.

Taxing emission internalizes the externality as firm will be forced to control the pollution. Output can be taxed but companies can pass tax burden to consumers if demand is inelastic.

There will be less error if exact between Qopt (Optimum quanity for society) and Qm (Actual market output) is known.

Amount of tax, elasticty of demand and actual gap output knowledge will help in minimising this negative externality.

Refer diagram below:

.msc I tax MPC Papt to weltuce loss pm -D MPB=MSB @opt Negative om production externally