7. Correcting for negative externalities - Taxes versus tradablepermits Power stations emit sutur diovide as a waste product. This generates a cost ta society that is not paid for by the firm, therefore, pollution is a eegative externality of power production. Suppose the US. government wants to correct this market failure by getting ferms to internalize the cost of pollution. To da this, the government can charge firms for pollution rights (the right ta emit a given quansity of suitur diovide). The foliowing graph shows the daly demand for pollution rights. Use the graph inaut tool to help you answer the fallowing questions You wif eot be praded on any changes you make to this graph Note Once you enter a value in a white feld, the graph and any conresponding amounts ie each grey feld wil change accordingly Graph Input Tool Daily Dermand for Polution Rights Quantity Demanded 315 Demand NN s as an a s o QUANTITY ons ofon Suppose the govemment has detarmined that the socialy optmal quantity of sultur diaxide emissions is 245 ilion tons per day One way govemments can charge firms for poltion rights is by imposing a perunit tax an emissions. A tax for price is this case) of per ton of ufur dexide emited will achieve the desired level of pollution Now uppese the US. government does nat know the demand curve for pollution and, therefore, cannet determne the optimal tax ta achieve the desired evel of pulution. Enstead, it auctions of tradable potutien permits. Each permit entities ts wner to emit one ton of sutur dexide per day. To acheve the sacally optimal quancty of polution, the govemment auctions off 24S ition pollution permits. Given this quantity of perms, the prtce for each permtin the market for polution rights will be The previous analys hinges on the government having good information regarding ether the demand for polun permts ar the optimal level of pollution (or batn) Given that the approprate poicy (tradatie permits or comective taes) can depand on the available infomation and the policy goal, consider he tutowing sconano Ae environmental tudy conducted ina partcular city sggests thatia chemical plant eits more than 0 mion tons of chemicals each year, the water supply wil became contaminated beyond the point where aration techniques can make it sate fr drining thss all the information the governmant ha, whih slution to reduce poluon is appropriate? Check at hat apply O Comective tass O tade permts

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firms matter for efficiency? Explain. 9. There are three industrial firms in Happy Valley. Initial Pollution Cost of Reducing Firm Level Pollution by 1 Unit A 30 units $20 В 40 units $30 C 20 units $10 The government wants to reduce pollution to 60 units, so it gives each firm 20 tradable pollution permits. a. Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation? b. How much higher would the costs of pollution reduction be if the permits could not be traded? Answers

3. The effect of negative externalities on the optimal quantityof consumption Consider the market for paper. Suppose that a paper factory dumps toxic waste into a nearby river, creating a negative externality for those living downstream from the factory. Producing an additional ton of paper imposes a constant external cost of $385 per ton. The following graph shows the demand (private value) curve and the supply (private cost) curve for paper. Use the purple points (diamond symbol) to plot the social cost curve when the external cost is $385 per ton. PRICE (Dollars per ton of paper) 1100 990 880 770 660 550 440 330 220 110 0 0 ☐ 1 ☐ 2 3 4 5 QUANTITY (Tons of paper) O n Supply 8 (Private Cost) Demand (Private Value) 7 Social Cost (?) The market equilibrium quantity is tons of paper, but the socially optimal quantity of paper production is To create an incentive for the firm to produce the socially optimal quantity of paper, the government could impose a of paper. tons. of $ per ton