Ways of Correcting Market Failure Assumption: The market failure is pollution FiXed-proportion production technology Must reduce output to reduce emissions Use an output tax to reduce output o Input substitution possible by altering technology Chapter 18 Slide 11
Chapter 18 Slide 11 Ways of Correcting Market Failure ◼ Assumption: The market failure is pollution ⚫ Fixed-proportion production technology ◆Must reduce output to reduce emissions ◆Use an output tax to reduce output ⚫ Input substitution possible by altering technology
The Efficient level of emissions Assume: 1)Competitive market 2) Output and emissions decisions are independent per unit 3)Profit maximIzing output chosen of emissions MSC At Eo the marginal Why is this more efficient costof abating emissions than zero emissions? is greater than the marginal social cost 4 At E, the marginal social cost is greater than the marginal benefit The efficient level of emissions is 12(E) where MCA= MSC MCA 02468101214161820222426 Chapter 18 Level of emissions Slide 12
Chapter 18 Slide 12 The Efficient Level of Emissions Level of Emissions 2 4 6 Dollars per unit of Emissions 0 2 4 6 8 10 12 14 16 18 20 22 24 26 MSC MCA E* The efficient level of emissions is 12 (E*) where MCA = MSC. Assume: 1) Competitive market 2) Output and emissions decisions are independent 3) Profit maximizing output chosen At Eo the marginal cost of abating emissions is greater than the marginal social cost. E0 At E1 the marginal social cost is greater than the marginal benefit. E1 Why is this more efficient than zero emissions?
Ways of Correcting Market Failure a Options for Reducing emissions to EX ● Emission standard e Set a legal limit on emissions at E (12) Enforced by monetary and criminal penalties Increases the cost of production and the threshold price to enter the industry Chapter 18 Slide 13
Chapter 18 Slide 13 Ways of Correcting Market Failure ◼ Options for Reducing Emissions to E* ⚫ Emission Standard ◆Set a legal limit on emissions at E* (12) ◆Enforced by monetary and criminal penalties ◆Increases the cost of production and the threshold price to enter the industry
Standards and Fees per unit of emissions MSC Standard Fee MCA E 12 Level of emissions Chapter 18 Slide 14
Chapter 18 Slide 14 Standards and Fees Level of Emissions Dollars per unit of Emissions MSC MCA 3 12 E* Standard Fee
Ways of Correcting Market Failure a Options for reducing emissions to E Emissions Fee Charge levied on each unit of emission Chapter 18 Slide 15
Chapter 18 Slide 15 ◼ Options for Reducing Emissions to E* ⚫ Emissions Fee ◆Charge levied on each unit of emission Ways of Correcting Market Failure