PS 3 Solutions - Ec1661 - Spring 2016 - JohnF. Prof.RobertN.Stavins HarvardUniversity API135\/Econ1661 PROBLEM SET#3 SOLUTIONS Problem 1 True or False

PS 3 Solutions - Ec1661 - Spring 2016 - JohnF....

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John F. Kennedy School of Government           Harvard University Prof. Robert N. Stavins    API-135/Econ 1661 PROBLEM SET #3 SOLUTIONS Problem 1: True or False Please clearly label each statement True or False and explain your reasoning. a) Price-based instruments like taxes are always better than quantity-based instruments. False. Uncertainty in the cost curve can lead quantity-based instruments to outperform price-based instruments. Additionally, even in a case where we might favor a price-based instrument, positive correlation between benefits and costs may push us towards favoring a quantity-based instrument to such a degree that a quantity instrument is favored (see problem 2f for more information). b) “Grandfathering” command-and control (CAC) regulations (setting regulations based on a previous year’s emissions) can undermine cost-effectiveness by creating a bias against new capital investments. True. Vintage-differentiated regulation can reduce cost-effectiveness and even lead to higher levels of pollutant emissions than would occur in the absence of regulation. See Lecture 16 (slide 8) for further discussion. Note that this is not the case for “grandfathering” permits in a cap-and-trade system. c) Nationwide pollution taxes outperform performance standards in addressing “hot spots” because these taxes encourage firms to minimize total abatement costs, unlike standards. False. Using a nationwide environmental regulation to address pollutants with local impacts is not generically efficient. This policy choice is an example of “building a fast train to the wrong station,” or focusing on cost-effectiveness at the expense of efficiency. In general, environmental regulations should be applied at the spatial level of the damages incurred (or account for heterogeneity in damages across space). See pages 173-176 of the Keohane & Olmstead textbook for further discussion of this example.
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  • Spring '16
  • Robert Stavins
  • Economics, Pigovian tax, marginal cost function, marginal control costs

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