CHAPTER 16 Externalities, Pollution
Test Yourself
1. At equilibrium, the price is $8, and 90 units of X are sold. Consequently 900 pounds of pollution are emitted.
2. When suppliers receive a price of $7, they produce 85 units. Consumers pay a price of $9 and demand 85 units. With a tax of $2 a unit, there must be a gap between the consumers’ price and the producers’ price of $2. Reading along the table, one can see that with this $2 gap, supply and demand are equal at a market price of $9, with sales equal to 85 units.
3. There are now 850 pounds of emissions.
4. The $2 tax reduces emissions by 50 pounds.
Discussion Questions
2. (a) The tax per unit of emissions should equal the money value of the damage caused by a marginal unit of those emissions. Of course this is easier said than done. It may be difficult to measure the value of the damage done, and it may even be difficult to figure out what kind of damage is being done. Estimates will have to be made. If estimates of damage are too difficult, then a second-best solution is to pick an amount by which you wish pollution to fall, and then select the tax that will achieve this reduction.
(b) The best course to pursue with a municipal plant depends upon the behavior of the plant. If the plant is short of money (as is usually the case), then the imposition of a tax will lead it to try to avoid the tax by reducing pollution, just as a private firm would. On the other hand, if the plant managers are not concerned with profitability, and simply pass additional costs on to the customers, then a tax will not induce any change in their behavior, and the authorities will have to resort to regulation, mandating a certain cut in smoke emissions.
(c) The tax should depend upon the value of the damage, and this is likely to vary positively with the density of the population. One could, however, imagine the opposite situation, in which smoke pollution altered a pristine landscape in a major way but made little difference to an already smoggy city; in this case the tax should be greater in the rural area.
Before making these decisions, you would need to know how the tax would be levied (e.g. per-unit of production or emission, thus adding to the firm’s marginal costs), the basis for the firm’s decision (e.g. profit-maximizing, regulated monopoly . . .), and the actual amount of damage the pollution caused in the surrounding environment.
3. Valid objections to a price increase of a scarce resource have to do with its impact upon income distribution. The price increase hurts poor people more than rich, and it may be a windfall gain to some producers. But it is not valid to object to a price increase of a scarce resource on the grounds that it hurts all consumers or that it is a result of manipulation by speculators—since the price increase is actually a consequence of the scarcity of the resource, and since it will produce desirable results, namely conservation of the resource and substitution of alternative resources.
4. Initially when fuel prices rise, people are stuck with their existing equipment, and cannot reduce fuel consumption unless they are prepared to reduce their output, consumption, travel, etc. But over time, they can switch to more fuel-efficient cars, buildings, machines and so forth, and as a consequence they can enjoy the same level of output with less use of fuel. In other words, the price elasticity of demand for fuel is likely to be greater in the long run than it is in the short run.