Exercise 6

Due Monday 3/7 Extended: due Wednesday 3/9

Suppose you are a state official charged with reducing sulfur dioxide (SO2) emissions from a group of three electric power plants. You have the following facts:

• The marginal damage caused by a ton of SO2 is $50,000. The marginal benefit of abating a ton of emissions (MBA) is thus $50,000.
• The three plants differ in the amount they are emitting now and in their marginal cost of abatement, as shown in the table below. The MCA variables indicate the marginal cost of abatement at each plant (MCA1 is the marginal cost in plant 1, etc) as a function of the number of tons of abatement done by the plant (Q1 is abatement done by plant 1, etc.). None of the plants are abating emissions now.

Please answer the following questions:

1. Compute the efficient amount of abatement for each plant. What is the total cost of abatement under this scenario?
2. How much would it cost to get the same overall reduction by requiring the plants to cut their emissions by an equal percentage? For example, if your answer to the previous step showed that emissions should be reduced by X% overall, how much would it cost if each plant cut its emissions by X%?
3. Suppose the government wants to control SO2 from the plants via an emissions tax. What should the tax be? What would be the total cost to each firm of complying with the policy (abatement cost plus any tax payments)?
4. If you approached the three plants, would they prefer the policy in (2) or the tax in (3)? Explain. Which policy do you, as an economist, prefer? Why?
5. Design a tradable permit policy that would achieve the reductions from (1) but would also equalize the overall cost of the policy across the three plants. How many permits should be issued? How many should each plant be allocated? What will the market price be? How many permits will each plant end up buying or selling?

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