Environmental Economics and Management Theory Policy and Applications 6th Edition Scott Callan – Test Bank

 

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CHAPTER 5
Economic Solutions to Environmental Problems: The Market Approach

 

 

TRUE-FALSE

1. The major categories of market instruments are: pollution charges, deposit/refund systems, subsidies, and pollution permit trading systems.

Answer:           T

2. A payment or tax concession aimed at lowering the cost of abating is called a pollution charge.

Answer:           F

3. Because polluters ignore the MEC of environmental damage linked to the production of a good, too few resources are allocated to producing that good.

Answer:           F

4. A pollution charge follows the “polluter-pays principle.”

Answer:           T

5. If production of a good generates an environmental negative externality, the effect of that externality is captured by the MEC of production.

Answer:           T

6. A Pigouvian tax is a charge on a good whose production generates a negative externality, such that the charge is equal to the MEC at the competitive output level.

Answer:           F

7. In the single-polluter case, a firm faced with an emission charge for pollution implemented as a marginal tax (MT) will abate as long as MAC < MT.

Answer:           T

8. In the multiple-polluter case, each firm faced with an emission charge implemented as a marginal tax (MT) abates up to the point where MAC equals MT, which results in a cost-effective solution.

Answer:           T

 

9. If firms abate to the point where each firm’s MAC equals the marginal tax, an efficient solution will result.

Answer:           F

10. Of all the market-based policy instruments used to combat environmental damage, the pollution charge is the most commonly used worldwide.

Answer:           T

11. According to the textbook application, the United States pays a higher tax rate on gasoline than any nation in the European Union (EU).

Answer:           F

12. If firm 1 and firm 2 each face an marginal abatement cost of MAC₁ = 5A₁ and MAC₂ = 3A₂, respectively, and if the combined abatement level must be 16 units, then firm 1 must abate 6 units and firm 2 must abate 10 units in order to achieve the cost-effective solution.

Answer:           T

13. Suppose that for some abatement equipment market, the MSB = 525 – 1.2Q and MPB = 325 – 0.8Q, then the Pigouvian subsidy for that market must equal 200 – 0.4Q at Q_E to achieve an efficient outcome.

Answer:           T

14. Suppose that for some abatement equipment market, the MSB = 502 – 1.2Q, and MPB = 302 – 0.8Q, then the Pigouvian subsidy must equal 804 – 2Q at the efficient output level to achieve the efficient output level.

Answer:           F

15. Compared to an abatement equipment subsidy, a per-unit subsidy on abatement might be less disruptive to the market because it is defined without any influence as to how abatement is achieved.

Answer:           T

16. In a deposit-refund system, the deposit makes the polluter internalize the externality by absorbing the cost of any damage it might generate in advance.

Answer:           T

 

17. To effectively internalize the externality, the deposit component of a deposit-refund system must raise the MPC of illegal waste disposal by the MEC measured at the competitive output level.

Answer:           F

19. Suppose that Firm 1 and Firm 2 face marginal abatement costs of MAC₁ = 2.5A₁ and MAC₂ = 1.5A₂, respectively, and that tradeable permits for pollution are issued such that a total of 20 units must be abated. If firm 1 abates 7.5 units, and firm 2 abates 12.5 units, then both firms have an incentive to trade.

Answer:           F

20. If Firm X is abating 9 units with an MAC_X = 0.6A_X, and Firm Y is abating 11 units with an MAC_Y = 0.9A_Y, then Firm Y should do less of the abating and Firm X should do more in order to lower the overall costs of abatement.

Answer:           T

 

 

 

MULTIPLE CHOICE

1. Major categories of market-based instruments include
2. pollution charges d.         pollution permit trading systems
3. subsidies e.         all of the above
4. deposit/refund systems

 

Answer:           e.

 

2. A product charge is
3. a fee added to the price of a pollution-generating product based on its contribution to pollution
4. the same as an effluent charge
5. a fee imposed on the actual release of pollution, typically as a tax
6. none of the above

 

Answer:           a.

 

3. In the single-polluter case, suppose a firm faces an emission charge implemented as a marginal tax (MT) of 12 and that its MAC = 0.8A. Based on this information, the firm
4. is better off paying the tax at abatement levels below 15 units
5. should abate pollution for all abatement levels up to 15 units
6. is better off paying the tax as long as the abatement level is 1.5 units or less
7. none of the above

 

Answer:           b.

 

4. In the multiple-polluter case, each firm faced with an emission charge imposed as a marginal tax (MT) abates as long as
5. its MAC < MT c.         its MAC is negatively sloped
6. its MAC > MT d.         its TAC are lower than its total tax burden

 

Answer:           a.

 

5. The pollution charge
6. is the most commonly used market-based instrument internationally
7. is sometimes implemented as an effluent charge to protect water resources
8. can be used to control noise pollution
9. all of the above
10. none of the above

 

Answer:           d.

 

6. An emission charge
7. takes advantage of firms’ natural profit incentive
8. cannot achieve a least-cost solution
9. offers no revenue stream to governments
10. has no effect on product pricing

 

Answer:           a.

 

7. The tax imposed on gasoline
8. is an example of a product charge
9. has no effect on consumption
10. is used exclusively in the United States
11. is set at a relatively high rate in the United States

 

Answer:           a.

 

8. A subsidy
9. used in an abatement equipment market can achieve an efficient solution if the subsidy is set equal to the MEB at Q_E
10. on pollution reduction activity encourages firms to reduce pollution below a predetermined standard
11. on abatement equipment can create bias by changing the relative prices of various abatement technologies
12. all of the above
13. (a) and (b) only

 

Answer:           d.

 

9. A Pigouvian subsidy
10. cannot achieve an efficient outcome
11. is a per-unit payment on a good that is set equal to the marginal external benefit at Q_E
12. achieves efficiency as long as it is set equal to the MEC at the competitive output level
13. lowers the MPB vertically by the amount of the subsidy

 

Answer:           b.

 

10. Per-unit pollution reduction subsidies
11. are implemented by paying a polluter for using a particular type of abatement equipment
12. can elevate profits, which encourages entry, and hence can perversely increase aggregate emissions
13. are used exclusively in the United States at the federal level of government
14. are designed to lower the costs of abatement technology

 

Answer:           b.

 

11. The key components of a tradeable pollution permit system include
12. a deposit that covers the MEC of improper waste disposal
13. the issuance of a fixed number of permits
14. a means through which permits can be exchanged among polluters
15. all of the above
16. (b) and (c) only

 

Answer:           e.

 

 

 

 

12. According to the model of a deposit-refund system
13. the deposit paid captures the MSC of improper waste disposal (MSC_IW)
14. the refund represents the MPB of improper waste disposal (MPB_IW)
15. if the deposit is set equal to the MEC_IW at the competitive equilibrium, the efficient outcome is achieved
16. the deposit converts the excess amount of illegal waste disposal to legal waste disposal
17. none of the above

 

Answer:           d.

 

13. In a deposit-refund system,
14. the refund component rewards potential polluters for proper disposal or recycling activity
15. the deposit should be set equal to the MSC of illegal waste disposal to achieve efficiency
16. monitoring and enforcement costs are higher than if a pollution charge were used
17. actual polluters are not penalized for actions that harm the environment

 

Answer:           a.

 

14. Real-world applications of deposit-refund systems include
15. programs implemented through state bottle bills
16. initiatives aimed at proper disposal of lead-acid batteries
17. programs that create incentives to return scrapped vehicles
18. all of the above
19. none of the above

 

Answer:           d.

 

15. In the multiple-polluter case for a pollution permit system, suppose Firm 1 and Firm 2 face marginal abatement cost functions of MAC₁ = 4.5A₁ and MAC₂ = 2.25A₂, respectively. If the government issues each firm tradeable pollution permits such that each has to abate 10 units of pollution, then, based on this allocation,
16. the two firms have no incentive to trade
17. firm 1 has an incentive to buy a permit if the price is greater than $45
18. firm 2 has an incentive to buy a permit if the price is above $22.50
19. firm 2 will be willing to sell a permit if the price is above $22.50

 

Answer:           d.

 

16. In the multiple-polluter case for a pollution permit system, suppose two firms, X and Y, face marginal abatement costs of MAC_X = 1.2A_X and MAC_Y = 0.4A_Y, respectively. To meet water quality standards, the government issues each firm pollution permits such that each firm must abate 20 units of pollution. If permit trading were allowed,
17. firm X would have an incentive to buy a permit as long as the price were less than $24
18. firm Y would be willing to sell a permit as long as the price were less than $8
19. at a permit price of $22, firm X would have an incentive to buy, but firm Y would have no incentive to sell
20. no trading would take place because neither firm has an incentive to trade based on this model

 

Answer:           a.

17. When comparing a permit trading system to the use of a pollution charge
18. a permit trading system requires more government intervention because the government must determine the permit price
19. a permit trading system is inflexible because the number of permits cannot be adjusted
20. a pollution charge generates revenue for the government on all units of pollution not abated
21. pollution charges might create pollution hot spots

 

Answer:           c.

 

18. A pollution permit trading system
19. is not a market-oriented policy instrument
20. is used to combat acid rain in the United States
21. is not viable on an international level
22. is not capable of achieving a cost-effective solution

 

Answer:           b.

 

 

 

 

SHORT PROBLEMS

 

1. Assume that there are two firms, each emitting 20 units of pollutants into the environment, for a total of 40 units in their region. The government sets an aggregate abatement standard (A_ST) of 20 units. The polluters’ cost functions are as follows, where the dollar values are in thousands:

Polluter 1:        TAC₁ = 10 + 0.75(A₁)²,                       Polluter 2:        TAC₂ = 5 + 0.5(A₂)²,                                       MAC₁ = 1.5A₁,                                                            MAC₂ = A_2.

1. What information does the government need to support an assertion that the 20-unit abatement standard is allocatively efficient?
2. Suppose that the government allocates the abatement responsibility uniformly, requiring each polluter to abate 10 units of pollution. Quantitatively assess the cost implications.
3. Now, assume that the government institutes an emission fee of $16 thousand per unit of pollution. How many units of pollution would each polluter abate? Is the $16 thousand fee a cost-effective strategy for meeting the standard? Explain.
4. If instead the government used a pollution permit system, what permit price would achieve a cost-effective allocation of abatement? Compare the costs of this allocation to the costs of using the uniform standard described in part (b).

Solution

 

1a.       For allocative efficiency to be achieved in this region, it must be the case that the MSC and MSB of pollution abatement are equal at the 20-unit level. Thus, in addition to knowing the marginal social benefit (MSB) for each region, the government must also know the MAC of each polluter and the government’s marginal cost of enforcement (MCE), since MSC = MAC_mkt+ MCE.

1. Assuming a uniform standard of 10 units, MAC₁ = 1.5(10) = $15 thousand, while MAC₂ = $10 thousand. TAC₁ = 10 + 0.75(10)² = $85 thousand and TAC₂ = 5 + 0.5(10)² = $55 thousand, for an overall total cost in the region of $140 thousand. Since the MACs are not equal at a 10-unit abatement level per firm, the method is not cost-effective. This is expected when a uniform standard is imposed across polluters.
2. Faced with a $16 thousand pollution charge, each polluter will abate as long as its MAC is less than $16 thousand and pay the fee when the opposite condition holds. Hence, polluter 1 will abate up to the point where MAC₁ equals $16 thousand. Algebraically, this is found as follows:

MAC₁   =          16

1.5(A₁) =          16, which implies A₁ = 10.67 units.

Analogously, polluter 2 abates up to the point where MAC₂ equals $16 thousand, found as:

MAC₂   =          16

A₂        =          16 units

Notice that although the pollution charge brings about equal MACs across polluters, the total abatement level for the region is 26.67 units, which is higher than what is required. This means that the fee is set too high to meet the standard and too many resources are being allocated to pollution abatement. Total costs of abatement are: TAC₁ = 10 + 0.75(10.67)² = $95.39 thousand and TAC₂ = 5 + 0.5(16)² = $133 thousand, or $228.39 thousand for the entire region. This result underscores the difficulty in setting the appropriate level of a pollution charge to meet a given abatement level.

20. Under a tradeable permit system, the government issues (or sells) an aggregate number of permits equal to the level of pollution deemed acceptable by the objective. In this case, 20 units of abatement are required to reduce the existing 40 levels of pollution down to 20. Hence, the government will issue 20 one-unit permits to the two polluters, who may then exchange these with one another in an open market. The two polluters will buy and sell permits as long as there are gains from trading. The high-cost abater would be willing to purchase permits as long as the selling price is lower than its MAC. The low-cost abater would be willing to sell a permit as long as it receives a price higher than its MAC. Trading will continue until the price reaches the point where neither firm has anything further to gain from an exchange. This occurs when both polluters are abating at the point where their MACs are equal.

Solving this algebraically, the two MAC functions should be set equal to one another, subject to the abatement constraint of 20 units.

MAC₁   =          MAC₂, subject to A₁ + A₂ = 20

\         1.5A₁   =          A₂

1.5(20 – A₂)     =          A₂

A₂           =         12, so

A₁        =          8

At these abatement levels, MAC₁ = MAC₂ = $12 thousand. What this means is that a permit price of $12 thousand yields a cost-effective solution. Notice that TAC₁ = 10 + 0.75(8)² = $58 thousand and TAC₂ = 5 + 0.5(12)² $77 thousand, for a total abatement cost in the region of $135 thousand. This is $93.39 thousand lower than the costs incurred using the uniform standard analyzed in part (b).

 

 

2. Consider the following abatement cost functions (TAC_O and MAC_O) for a firm using an old abatement (A_O) technology:

TAC_O = 1000 + 0.25(A_O)²                                         MAC_O = 0.5(A_O),

where A is units of abatement undertaken by the firm, and the cost values are in thousands of dollars.

Further assume that the regulatory authority has set an abatement standard (A_ST) equal to 40 units for each firm and has proposed an emission charge implemented as a constant per unit tax (t) of $10 (i.e., MT = 10), where Total Tax = t(A_ST – A_i), and A_i is the existing abatement level.

1. If the state enacts the emission charge, find the associated cost savings to the firm, assuming the use of the old technology.
2. Now suppose that the firm is contemplating the use of a new abatement (A_N) technology, which would generate the following cost functions:

TAC_N = 1000 + 0.125(A_N)²                                       MAC_N = 0.25(A_N)

Find the cost savings to the firm of using this new technology when faced with the emission charge.

Solution

2a.       Using the old technology, the total abatement costs of meeting the 40-unit abatement standard are: TAC_O = 1000 + .25(40)² = $1,400 thousand.

Faced with the emission charge, the firm would abate up to the point where the tax is equal to its MAC, which is found as follows:

MT = MAC_O

10 = 0.5(A_O), so A_O = 20

Therefore, the firm’s total abatement costs would be TAC_O = 1000 + .25(20)² = $1,100 thousand.

Since the actual level of abatement (A_O) is less than the abatement standard of 40 units, the firm also will pay tax on the difference equal to Total Tax = t(A_ST – A_O) = $10(40 – 20) = $200 thousand.

Taken together, the firm’s total costs of meeting the abatement standard are the sum of the TAC_O and the tax, or $1,100 + $200 = $1,300 thousand.

Notice that the emission charge allows the firm to realize a cost savings of $100 thousand ($1,400 thousand – $1,300 thousand).

1. As in part (a), the abatement level the firm would undertake when faced with the $10 emission charge is as follows:

MT                   =          MAC_N
0.25(A)            =          10,       so A_N=40 units.

Because of the cost savings associated with the new technology, the firm would abate at a higher level, in this case up to the standard of 40 units. The associated total abatement costs are TAC_N = 1000 + 0.125(40)² = $1,200 thousand.

Since the firm avoids any tax payments, its total costs to meet the standard are just the abatement costs. Notice that the use of new technology saves the firm another $100 thousand.

 

 

3. To promote cleaner air, the federal government in the United States enacted tax incentives for purchasing new electric vehicles or clean-fuel vehicles. These were scheduled to be phased out over time.
4. Graphically illustrate the intended effect of this tax incentive, and explain the expected outcome of phasing it out. (Assume there is no production externality.)
5. An alternative approach is to raise taxes on gasoline and other fuels. What is the economic intuition of this policy?

Solution

3a.       The tax incentive is offered to consumers. Therefore, it can be modeled as a subsidy (s) aimed at internalizing the positive externality of driving more environmentally friendly cars. If s is set equal to the MEB at Q_E, an efficient solution is achieved.

Effectively, the incentive causes the MPB to shift up by the dollar amount of the subsidy. As this occurs, the equilibrium quantity rises, and, while the efficient price is higher, the effective price to the consumer (P_E – s) falls. As the tax incentive is phased out, the size of the subsidy is decreased, the MPB shifts back down, and the effective price rises.

 

1. The tax on gasoline is a product charge. Its intent is to internalize the negative externality of gasoline consumption. Intuitively, such a policy instrument changes relative prices, in this case between gasoline and alternative fuels. As the effective price of gasoline rises with the tax, quantity demanded falls, ceteris paribus. Quantity falls because consumers rationally move away from the relatively expensive good, gasoline, and move toward gasoline substitutes, i.e., alternative fuels.

 

 

 

 

 

CASE studY

Case 5.1:         State Bottle Bills

Currently, 10 states have passed bottle bills: California, Connecticut, Hawaii, Iowa, Maine, Massachusetts, Michigan, New York, Oregon, and Vermont. Although each state’s law is unique, there are similarities that characterize how a deposit/refund system for beverage containers is designed. Chief among these is the fact that consumers and retailers have a natural incentive to return used containers so that they can recover their deposits. In that sense, bottle bills are self-implementing. Once the deposit system is in place, market forces take over.

Aside from the economic rationale for these market instruments, they are also credited with achieving significant environmental gains. Among these are markedly higher return rates for beverage containers and reduced littering.

All of this begs the obvious question. Why haven’t more states passed bottle bills? The quick answer is that there has been sufficiently strong voter opposition at the state level to prevent more widespread use of these particular deposit/refund systems.

1. Investigate and then summarize several reasons why voters oppose the passage of bottle bills.
2. Research the case of Hawaii, the most recent state to pass a bottle bill. Identify the process undertaken to gain approval of this bill. What were the chief concerns of voters, and how did proponents address these reservations?

 

Sources:  Container Recycling Institute (2011); U.S. EPA, Office of Policy, Economics, and Innovation (January 2001).