Res econ 262- 4/11/17
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Intro- The switch from command and control policy to incentive-based policy. An emission tax is
the easiest form of the incentive-based policy.
When you have uncertainty and asymmetric info, things get complicated.
Uncertainty- firm does not know marginal abatement cost.
Asymmetric info- when someone knows more about information than someone else
As long as the MAC is lower than the tax- the firm will reduce its emissions. It is cheaper for the
firm to bear the additional abatement cost of reducing emissions than to pay the tax.
On the other hand: As long as MAC is higher than the tax, the firm will not control its emissions
(its cheaper to pay the tax than to control the emissions)
. If the environmental authority knows the firm’s MAC it can induce any level of emissions it
wants by choosing the appropriate tax. However, if it is uncertain about the firm’s MAC, then it
will not be able to guarantee that the firm will choose the level of emissions that it wants.
With its estimated MAC the regulator will impose the tax t , hoping that the firm will respond by
choosing E . But the firm doesn’t do this. It equates t to its true MAC and chooses E > E 0
emissions. Thus if the regulator underestimates MAC, emissions will be higher than the target.
If the regulator over-estimates MAC, the firm’s emissions will