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ECON 1000 Quiz: Micro4th ppt notes ch10 pt2

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ECON 1000
Avi Cohen

▪ Market-based policies provide incentives so that private decision-makers will choose to solve the problem on their own. ▪ Market-Based Policy #1: Pigovian Taxes & Subsidies ▪ Instead of regulating behaviour in response to an externality, the government can use market-based policies to align private incentives with social efficiency. ▪ Pigovian tax: a tax designed to induce private decision-makers to take account of the social costs that arise from a negative externality ▪ The ideal corrective tax = external cost ▪ For activities with positive externalities, ideal corrective subsidy = external benefit ▪ Market-Based Policy #1: Pigovian Taxes & Subsidies ▪ Example: Two companies (firm A and firm B) run coal-burning power plants that each emit 40 tonnes of sulfur dioxide per month. SO causes acid rain & other health issues. 2 ▪ Policy goal: reducing SO2emissions. ▪ Policy options • regulation: requires each plant to cut emissions by a certain tonnage. • Pigovian tax: Make each plant pay a tax on each tonne of SO em2ssions. Set tax at level that achieves goal. ▪ Market-Based Policy #1: Pigovian Taxes & Subsidies ▪ The regulation dictates a level of pollution. ▪ The tax would give factory owners an economic incentive to reduce pollution. ▪ Most economists prefer the tax approach. ▪ Taxes reduce pollution more efficiently. ▪ Market-Based Policy #1: Pigovian Taxes & Subsidies ▪ Suppose cost of reducing emissions is lower for firm A than for firm B. ▪ Socially efficient outcome: firm A reduces emissions more than firm B. ▪ The Pigovian tax is a price on the right to pollute. ▪ Like other prices, the tax allocates this “good” to the firms who value it most highly (firm B). ▪ Market-Based Policy #1: Pigovian Taxes & Subsidies ▪ Under regulation, firms have no incentive to reduce emissions beyond the 5 tonne target. ▪ A tax on emissions gives firms incentive to continue reducing emissions as long as the cost of doing so is less than the tax. ▪ If a cleaner technology becomes available, the tax gives firms an incentive to adopt it. ▪ Market-Based Policy #1: Pigovian Taxes & Subsidies ▪ Other taxes distort incentives and move the allocation of resources away from the social optimum. ▪ When externalities are present however, society also cares about the well-being of its bystanders who are affected. Pigovian taxes therefore move the allocation of resources closer to the social optimum. ▪ Pigovian taxes raise revenue for the government and enhance economic efficiency. ▪ Example of a Pigovian Tax: The Gas Tax The gas tax targets three negative externalities: ▪ congestion the more you drive, the more you contribute to congestion ▪ accidents larger vehicles cause more damage in an accident ▪ pollution burning fossil fuels produces greenhouse gases Policy goal: Reducing gasoline consumption Two approaches: A. Enact regulations requiring automakers to produce more fuel-efficient vehicles B. Significantly raise the gas tax ▪ Market-Based Policy #2: Tradeable Pollution Permits ▪ Recall: Firm A and firm B each emit 40 tonnes SO ,2total of 80 tonnes. ▪ Goal: reduce emissions to 60 tonnes/month. ▪ Suppose cost of reducing emissions is $100/ton for firm A, $200/ton for firm B. ▪ If regulation requires each firm to reduce 10 tonnes, cost to A: (10 tonnes) x ($100/tonne) = $1,000 cost to B: (10 tonne
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