ECN 104 Chapter Notes - Chapter 16: Marginal Utility, Social Cost, Pigovian Tax

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greenhedgehog390

22 Nov 2016

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An external cost is an uncompensated cost that a firm imposes on others. An external benefit is a benefit that a firm gives to others without receiving any compensation. Pollution is a bad thing, but still, pollution only comes from things that provide us with some benefit. Pollution is a side effect of useful activities, so the optimal quantity of pollution is not zero. The marginal social cost (msc) of pollution is the additional cost imposed on society as a whole by an additional unit of pollution. The marginal private cost (mpc) of pollution is the cost charged to the polluter who is creating an extra unit of pollution. The marginal external cost (mec) of pollution is cost imposed on others while the polluter creates another unit of pollution. The sum of the willingness among all members of society to avoid that unit of pollution.

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7. Correcting for negative externalities - Regulation versus tradable permits Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods: Available Methods to Reduce Pollution 1. The government sets pollution standards using regulation. 2. The government allocates tradable pollution permits. Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces to eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive. Firm Cost of Eliminating the . . . First Unit of Pollution Second Unit of Pollution Third Unit of Pollution (Dollars) (Dollars) (Dollars) Firm X 80 130 210 Firm Y 550 700 1,075 Firm Z 75 90 130 Now, imagine that two government employees propose alternative plans for reducing pollution by 6 units. Method 1: Regulation The first government employee suggests to limit pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units. Complete the following table with the total cost to each firm of reducing its pollution by 2 units. Firm Total Cost of Eliminating Two Units of Pollution (Dollars) Firm X Firm Y Firm Z Method 2: Tradable Permits Meanwhile, the other employee proposes using a different strategy to achieve the governmentâs goal of reducing pollution in the area from 12 units to 6 units. He suggests that the government issue two pollution permits to each firm. For each permit a firm has in its possession, it can emit 1 unit of pollution. Firms are free to trade pollution permits with one another (that is, buy and sell them) as long as both firms can agree on a price. For example, if firm X agrees to sell a permit to firm Y at an agreed-upon price, then firm Y would end up with three permits and would need to reduce its pollution by only 1 unit, while firm X would end up with only one permit and would have to reduce its pollution by 3 units. Assume the negotiation and exchange of permits are costless. Because firm Y has high pollution-reduction costs, it thinks it might be better off buying a permit from firm Z and a permit from firm X, so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm Z and firm X willing to sell one of their permits to firm Y ? Check all that apply. $124 $166 $200 $364 $475 Suppose the owners of the three firms get together and agree on a trading price of $147 per permit. Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it costs each firm to reduce pollution to the necessary level. If a firm purchases two permits, assume that it buys one permit from each of the other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.) Firm Initial Pollution Permit Allocation Action Final Amount of Pollution Eliminated Cost of Pollution Reduction (Units of pollution) (Units of pollution) (Dollars) Firm X 2 Firm Y 2 Firm Z 2 Regulation Versus Tradable Permits Determine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this table.) Proposed Method Total Cost of Eliminating Six Units of Pollution (Dollars) Regulation Tradable Permits In this case, you can conclude that eliminating pollution is costly to society when the government regulates each firm to eliminate a certain amount of pollution than when it allocates pollution permits that can be bought and sold.

byzantiumcamel839

Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods:

	Available Methods to Reduce Pollution
1.	The government sets pollution standards using the regulation.
2.	The government allocates tradable pollution permits.

Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces to eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive.

Firm	Cost of Eliminating the...
	First Unit of Pollution	Second Unit of Pollution	Third Unit of Pollution
	(Dollars)	(Dollars)	(Dollars)
Firm X	80	100	150
Firm Y	450	800	1,050
Firm Z	95	120	200

Now, imagine that two government employees proposed alternative plans for reducing pollution by 6 units.

Method 1: Regulation

The first government employee suggests limiting pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units.

Complete the following table with the total cost to each firm of reducing its pollution by 2 units.

Firm	Total Cost of Eliminating Two Units of Pollution
Firm	(Dollars)
Firm X	?
Firm Y	?
Firm Z	?

Method 2: Tradable Permits

Meanwhile, the other employee proposes using a different strategy to achieve the government's goal of reducing pollution in the area from 12 units to 6 units. This employee suggests that the government issue two pollution permits to each firm. For each permit a firm has in its possession, it can emit 1 unit of pollution. Firms are free to trade pollution permits with one another (that is, buy and sell them) as long as both firms can agree on a price. For example, if firm X agrees to sell a permit to firm Y at an agreed-upon price, then firm Y would end up with three permits and would need to reduce its pollution by only 1 unit while firm X would end up with only one permit and would have to reduce its pollution by 3 units. Assume the negotiation and exchange of permits are costless.

Because firm Y has high pollution-reduction costs, it thinks it might be better off buying a permit from firm X and a permit from firm Z so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm X and firm Z willing to sell one of their permits to firm Y? Check all that apply.

$102

$164

$179

$410

$708

Suppose the government has set the trading price of a permit at $182 per permit.

Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it costs each firm to reduce pollution to the necessary level. If a firm is willing to buy two permits, assume that it buys one permit from each of the other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.)

Firm	Initial Pollution Permit Allocation	Action	Final Amount of Pollution Eliminated	Cost of Pollution Reduction
Firm	(Units of pollution)	Action	(Units of pollution)	(Dollars)
Firm X	2	?	?	?
Firm Y	2	?	?	?
Firm Z	2	?	?	?

Regulation Versus Tradable Permits

Determine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this table.)

Proposed Method	Total Cost of Eliminating Six Units of Pollution
Proposed Method	(Dollars)
Regulation	?
Tradable Permits	?

In this case, you can conclude that eliminating pollution is more/less costly to society when the government distributes tradable permits than when it regulates each firm to eliminate a certain amount of pollution.

taupeferret828

Question 1

An externality

		enhances market efficiency.
		is a private cost or benefit that results from the production or consumption of a good or service that is external to a market.
		is a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service.
		refers to production or consumption that occurs outdoors.

5 points

Question 2

Externalities can be produced by:

		the high price of goods and services
		individuals; firms
		market prices; market incomes
		oceans; streams

5 points

Question 3

When an external cost exists that is NOT taken into account in the production of a product,

		the level of output is too high, and the supply curve should shift to the left to account for the externality.
		the price of the product is too high, and production should be expanded to lower the price.
		the level of output is optimal, and there should be no change in the supply curve.
		the level of output is too low, and the supply curve should shift to the right to account for the externality.

5 points

Question 4

Which of the following is correct?

		MSC = MPC - MD
		MPC = MSC + MD
		MSC = MPC + MD
		MD = MSC + MPC

5 points

Question 5

If external costs (costs of cleaning up) are included and added to a firm's private costs, then

		the demand curve will shift to the left.
		the supply curve will shift to the right.
		the demand curve will shift to the right
		the supply curve will shift to the left.

5 points

Question 6

The Coase Theorem states that

		government intervention is always needed if externalities are present.
		assigning property rights is the only thing the government should do in a market economy.
		if transaction costs are low, private bargaining will result in an efficient solution to the problem of externalities.
		a free-market equilibrium is the best solution to address externalities.

5 points

Question 7

Buffalo in the United States almost became extinct while cattle, an animal that provides similar products, never have been close to extinction. The difference is due to

		the use of private property rights on cattle and common property rights on buffalo.
		the greater marginal value of a head of cattle relative to buffalo, leading to over-hunting of buffalo.
		cattle existing in Europe also while buffalo were specific to North America.
		the greater marginal value of a buffalo relative to a steer, leading to the overharvesting of buffalo.

5 points

Question 8

In theory, the Emissions Fee would

		cause firms to generate less pollution than their allowed limits.
		raise the production costs of all firms.
		cause firms to generate more pollution than their allowed limits.
		lower the production costs of all firms.

5 points

Question 9

A cap-and-trade policy

		has a set number of permits.
		allows polluters to trade permits.
		caps the total level of pollution allowed.
		all of the above.

Question 10

A Pigouvian tax corrects for

		market congestion.
		market losses.
		inefficient sales.
		low market prices.

harlequingoldfish8

ECN 104 Chapter Notes - Chapter 16: Marginal Utility, Social Cost, Pigovian Tax

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