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Unformatted text preview: EEP 101/ECON 125 Lecture 7 Shadow Pricing and Heterogeneity DAVID ZILBERMAN Outline Cost effectiveness Shadow pricing Heterogeneity Taxes vs. direct control Uncertaintythe Weitzman model Cost Effectiveness Policymakers frequently do not know the externality cost. They, therefore, set a target level of externality control and design a policy to meet it. Cost effective policy attains a target policy at least cost. Cost Effective Tax & Competition MPC Qc Target level 1 Target level 2 A B C D AB tax targets level 2 CD tax targets level 1 The tax levels are shadow prices of pollution constraints Shadow prices = the benefits lost by tightening a constraint Q1 Q2 Policies to Achieve Cost Effectiveness A tax, subsidy, tradable trading among firms MB = 20  2Q MPC = 4 initial equilibrium 20  2Q  4 = 0 Hence, Qc = 8, Pc = 4 When target is Q1 = 4, shadow price = 20  8  4 = 8 Total subsidy cost (8  4) * 8 = 32 When target is Q1 = 2, shadow price = 20  4  4 = 12 Total subsidy cost (8  2) * 12 = 72 Heterogeneity D2 D3 D1 TD = D1 + D2 + D3 MPC Q0 Q1 P1 Reduction from Q0 to Q1 Tax = Ab quantities moved from blue to red A B Numerical Heterogeneity MB1 = 20  Q, MB2 = 20  2Q, MB3 = 20  4Q MPC = 2 Quantity as function of price D1 = 20  P, D2 = 10  .5P, D3 = 5.  .25P Aggregate demand TD = 35  1.75PTD = 35  1....
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 Spring '09
 ZELBERMAN

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