Consider the market for paper. The process of producing paper creates pollution.
ID: 1140052 • Letter: C
Question
Consider the market for paper. The process of producing paper creates pollution. Assume that the marginal damage function for pollution is given by:
MDF = 3E
where damages are measured in dollars and E is the level of emissions. Assume further that the function describing the marginal abatement cost of emissions is given by MAC = 120 – E where benefits are measured in dollars and E is the level of emissions.
a)Graph the marginal damage function (MDF) and the marginal abatement cost function (MAC).
b)What is the unregulated level of emissions Eu? What is the social welfare of this emissions level?
c)Assume an existing emission quota limits emissions to E = 60. Show on the graph why this policy is inefficient. What is the deadweight loss caused by this policy?
d)Solve for the efficient emission quota. Assuming perfect compliance with this quota, what are the total costs of pollution? And what are the total costs of abatement?
e?If compliance with the quota becomes a problem, and the regulator is able to set a fine for noncompliance, what would be the optimal fine per unit of emission?
f)Now, rather than a quota, the regulator is able to set a tax on emissions. At what level should the tax be set? How much revenue would the tax generate? Indicate the tax revenue on your graph.
g)Now, rather than a quota or a tax, the regulator offers a subsidy for abatement. At what amount should the per-unit abatement subsidy be set? With this policy, what is the total subsidy payment? Indicate the subsidy payment on your graph.
Explanation / Answer
Marginal analysis involves a cost-versus-benefits comparison of various business activities. In marginal analysis, the cost of an activity is measured against incremental changes in volume to determine how the overall change in cost will affect the bottom line of a business. Marginal analysis can show the cost of additional production by a business all the way up to the break-even point. This is generally the maximum cost that a business can sustain without losing money.