PS6 - Economics 131: Problem Set #6 Question 1 The...

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Unformatted text preview: Economics 131: Problem Set #6 Question 1 The government of Babbage found out that the pollution level in its river Tiva is too high. In an effort to deal with this problem, the president brought the brightest minds among economists and ecologists in the country together to discuss possible policy options. The ecologists agreed on passing a new law where each firm can only produce a certain level of pollution. The economists disagreed with the ecologists and said that imposing a tax can get the target level of pollution. (a) In theory, assuming that you can get all information you need and given a target level of pollution, which policy is efficient? Explain clearly. (b) In practice, is the policy you propose in (a) necessarily going to get you to the target level of pollution? Question 2 So far, we have applied our tools to different environmental questions: (a) Rainforests (b) Water pollution (c) Bioprospecting For each of the above, (i) Explain what an economist defines as optimal for the specific question. If there are different ways of analyzing the problem, such as in the case of pollution one can think of pollution abatement vs. pollution level, please explain both and show how they are "mirror" images of each other. What is the main rule that we use to define optimality in all of these cases? (ii) Question 3 Dangerous levels of harmful pollutants are being released into Hayden Lake. A portion of the pollution comes from one large steel refinery. The remaining pollution comes from fertilizer runoff used on two nearby farms. Assume the marginal benefit, in dollars/year, of each unit of pollution, x tons/year, produced by the refinery is given by . Assume the aggregate marginal benefit to the farmers for each unit of pollution released is given by , where XF is the combined pollution generated by both farms. The social marginal cost of the pollution is given by Currently no policies are in place to reduce the level of pollution. . a) How much pollution will the refinery generate each year? How much pollution will the farms generate each year? b) How much surplus does the refinery receive from being allowed to pollute at the business as usual level? How much surplus do the famers receive? c) What is the total social cost of the business as usual level of pollution? What is the total economic surplus? The pollution generated by the refinery (a point source polluter) can be freely measured. The pollution from each farm (non-point sources) cannot be directly measured however. Therefore, the local government decides that it will impose a pollution tax on the refinery. d) At what level should the tax be set to maximize the total economic surplus? (Hint: since pollution generated by farmers is not taxed, the pollution they generate will remain unchanged from the business as usual case. Therefore, the social marginal cost of an additional unit of pollution from the refinery is given by e) What is the total economic surplus under the tax policy solved for in part (d)? The refinery owner argues that a more efficient outcome could be reached if the government imposes some form of pollution regulation on the famers as well. Recall, the government cannot observe the amount of pollution each farmer produces. Therefore, a pollution tax cannot be imposed on the farmers. Instead, the government decides to require the farmers to use a fertilizer that does not create any pollution. f) With the new regulation on the farmers in place, at what level should the pollution tax imposed on the refinery be set? g) Using the combined regulation and tax policy, what is the total economic surplus? Question 4 In the previous problem, we saw that it can be difficult to use a market mechanism (a tax, subsidy, or cap and trade policy) to reach the efficient level of pollution from non-point sources. If the pollution generated by each specific source cannot be directly measured, could a market mechanism still be used? If so, how? What other considerations besides economic efficiency must be considered in choosing between command and control regulations (technology standards for example) and market mechanisms? .) ...
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