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# hw3ansee11 - Homework 3 Solutions Environmental Economics...

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Homework 3: Solutions Environmental Economics: ECO 345 Question 1 The best option would be to introduce a Pigouvian tax on total BOD levels equal to the marginal damage and charge the tax to both firms, regardless of which firm emitted. Question 2 Marginal damages are flat if marginal costs are low, favoring taxes. Small errors in emissions cause little extra damages while small changes in the price of permits results in relatively large costs to firms. Conversely, if marginal costs are low marginal damages are steep, favoring permits. Since permits fixes emissions and therefore damages, while with taxes there is a risk that too many firms pay the tax, resulting in large emissions and therefore large damages. Since taxes are favored in one case and permits in the other, a hybrid system is best. A price floor fixes the price in the low case, like taxes, and fixes the quantity in the high case, like permits. Question 3 a. The government should tighten the standard (raise the MPG standard). b. The goverment should weaken the standard. c. To avoid (a), (the ratchet effect) firms may wish to keep the MPG low and not receive subsidies, so as not to reveal to the government that the cost of compliance is low. Question 4 a. We have: 1

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MC L 4 8 12 16 24 40 1 7 6 5 4 3 2 ¯ MC MC H MD P e Figure 1: High marginal cost case is steep. b. For the tax, we have: MD = 4 e = ¯ MC = 24 - 4 e, (1) 8 e = 24 e = 3 . (2) t = MD = 4 e = 4 · 3 = 12 . (3) Now if marginal costs are low, we have: t = MC L = 12 = 12 - 2 e, (4) e L = 0 . (5) 2
MD L = 4 e L = 0 . (6) Conversely, if marginal costs are high, we have: t = MC H = 12 = 40

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hw3ansee11 - Homework 3 Solutions Environmental Economics...

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