Externalities

: Externalities

Paper details:

1. Consider the market for bee hives in a rural area

a. Why might bee hives exhibit positive externalities in a rural area (hint: think of bees
primary ecological role)?

b. Draw a graph for the market for beehives. labeling the demand curve. the social value
curve. and supply curve

c. Indicate the market equilibrium quantity of beehives sold and the socially optimal
quantity that should be sold. Give an intuitive explanation for why these differ

d. Describe one command and control policy and one incentive-based policy that could
help correct this externality

2. We generally seem to think that levels of many pollutants in society are too high

a. If society wishes to reduce overall pollution by a certain amount. why is it efficient to
have different amounts of reduction coming from different firms?

b. Command-and-control policies often rely on uniform reductions in pollution across
firms. Why might these approaches generally have a hard time targeting the firms that
should be making the biggest reductions?

c. How might incentive-based regulations such as a corrective tax or tradable permit
system target firms that should undertake the biggest cost reductions?

3. Read the NY Times article titled “A Conservative Climate Solution’: Republican Group Calls for
Carbon Tax” from Feb 7th (available on Canvas under Files>Readings) and answer the following
questions:

a. Draw a graph of the regulated (i.e.. taxed) market for fossil fuels. assuming that the
damages are constant and roughly equal to the $40 tax per ton suggested in the

article. Show the supply. demand. and social cost curves. and label both the optimal
price P* and quantity q* as well as what the market price and quantity would have

been in the absence of regulation.

b. Given what we have already discussed about the science of climate change. do you
think that it is reasonable to assume that damages are constant as Co2 increases?
Why or why not?

c. Which of the standard for decision making (efficiency. safety. sustainability) do the
politicians in this article seem to be relying on the most? Make explicit reference to
THREE pieces of information contained in the article. and defend your answer.

d. What part of this article relates to the concept of a “double dividend”? How do the
Republican lawmakers and their environmental opponents disagree in this regard?

4. Imagine that there are three industrial firms in Haze Valley:

Firm Initial Pollution Level

Cost of Reducing Pollution by

1 unit

A 70 units $20

8 80 units $25

C 50 units $10

The government wants to reduce pollution to 120 units. so it gives each firm 40 tradable
permits.

a. Who sells permits and how many do they buy? Who buys permits and how many do
they sell? Explain why the sellers and buyers are each willing to do so-

b. What is the total cost of pollution reduction if we allow firms to trade as in part (a)?
How much higher would the costs of pollution reduction be if the permits could not be
traded?