Question

Paper factories emit chemicals 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 paper production. Imagine the Australian government wants to correct this market failure by getting tirms to internalise the cost ot pollution. To do this, the government can charge firms for pollution rights (the right to emit a given quantty of chemicals). The following graph shows the daily demand for pollution rights. Now imagine the Australian 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 tonne of chemicals 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 Use the graph input tooi to help you answer the following questions. You wil not be graded on any chanes you make to this graphi. Note: Once you enter a value in a white field, thピgraph and any 때 responding amounts in each grey field will change accordin 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 Graph Input Tool Daly Demand for Pollution Rights Price Dos per one 450 An environmental study conducted in a particular city suggests that if a chemical plant emits more than 20 million tonnes of chemicals each year, the water supply will become contaminated beyond the point where filtration techniques can make it safe for drinking If thls Is all the Information the government has, which solution to reduce pollution is appropriate? Check all that apply 0 0 1 00 10 40 4 QUANTITY s o Imaginc the government has determined that the socially optimal quantity of chemical pollution is 350 mllion tonnes per day Tradable permits Corrective taxes Onc way govcnments can charge tirms for pollution rights is by imposing a per unit tax on emissions. A tax (or price in this case) of per tonne of chemicals emitted will achieve the desired level of ution

Answer 1

The pollution is the byproduct of economic activity. The existence of pollution poses a direct cost on society which the producer of the pollution generally ignores while taking the economic decision. Thus, the market outcome often fails to generate social optimum in case of pollution and negative externality.

The demand curve given here gives the marginal benefit of pollution to the firm. The total benefit gets maximized when MB is zero or the demand curve touches the quantity axis. Then the benefit gets maximized at Q=500. For the level of pollution less than Q=500 level as the firm moves up along the demand curve for each unit less pollution the marginal benefit reduced. This reduction in benefit can be implied as the cost of abating pollution from maximum to the unit of pollution the firm currently emitting. That is for 400 units of pollution the marginal benefit is $18 per ton. This also implies not emitting additional (500-400)=100 unit costs $9 of benefit per ton.

The government use tax as the measure to correct the failure in the market and lead the market towards the social optimum. The tax acts as the price of pollution. Then the firm optimizes the level of pollution by equating P=MB amount of pollution. Hence, to reduce pollution to 350 million ton, the government should impose a tax=MB of 350 million ton. At Q=350, MB=$27 per ton. Then the tax should be $27/ ton.

In the case of pollution permit, the government auction off the total amount of pollution permissible in an open market. The firm buys the permit at a price equal to MB of the total amount sold. Thus, the market reaches optimum even if the government does not know the demand of the firms. In this case, the price of each permit will be $27.

Therefore, if the government only know how much to abate the optimum policy would be

• Pollution permit.