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chapter 10.doc

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ECON 260
Chris Bidner

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Chapter 10 Analytical Problems Answers 1. At the socially efficient level of emissions (E*=50), the total payments are $12000 (the TAC of $ 4500 plus compensation to salmon fishery of $7500). To show that total payments are minimized, consider increasing emissions to 51. The firm saves TAC of $295.5 but expects to pay additional compensation of $300 equal to the increase in TD to the fishery. The total payments therefore increase by $4.5. As the MD is greater than the TAC, for any increase in emissions above E*, the TAC saved must be less than the compensation paid and so total payments must increase. Going the other way, if emissions are reduced to 49, the additional TAC incurred is $305, while the damages and hence compensation saved is $297. Hence total payments increase by $8. As the MD is less than the TAC for any level of emissions below E*, the TAC incurred must be greater than the compensation saved and hence total payments must increase. It then follows that the only level of emissions for which total payments cannot be decreased is E*. This question provides an opportunity for more mathematically inclined students to practice their calculus. Integrating, we have Total payments (TP)= 800E-5E + 32000-3E 2 To minimize total payments, the first order necessary condition is: dTP/dE=800-10E-6E=0 (MAC = marginal compensation), giving E*= 50. The second order sufficient condition for a local minimum is satisfied as d TP/dE = -16 < 0. Hence E* = 50 is the level of emissions that minimizes total payments by the firm. 2. Total surplus to society (where society is represented by the two firms) is found by equating MAC to MD. 8E=800-10E gives E*= 44.44 tonnes. MAC(44.4) = $355.55. If the fishery initially has the property rights to a clean environment, the net gains from trading are (800× 44.4)/2 = $17,777.6. If the chemical factory initially has the property rights to pollute, the net gains from trading are (35.55× 640)/2=$11,377.76. In the text book example where the MD curve was less steep (MD= 6E), the gains from trade were $7200 if the chemical firm had initial property rights to pollute and $20,000 if the fishery had initial property rights to a clean environment. In both cases the gains from trade are larger if initially the fishery has property rights to a clean environment. This reflects the fact that if the fishery initially has the rights, then the initial allocation is further from the socially efficient allocation than if the chemical plant initially has the property rights. The social surplus gains have a higher variance in the text book case because the marginal damage curve i
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