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UNIT 6: ENVIRONMENTAL ECONOMICS

A. Optimal pollution is not zero
1. Pollution is a negative externality. Define E = emissions and A = abatement. The transfer function is E =
100 – 2A. Abatement costs are C = 20A + A2 while the benefits are B = 100A – A2. Provide a labelled
diagram to quantify optimal pollution.

2. What is the “marginal cost of pollution abatement”?

a. the social cost of producing one additional unit of pollution

b. the private cost of producing one additional unit of pollution
c. the cost of reducing pollution by one additional unit
d. the cost of the last unit of pollution produced

3. When the marginal costs of pollution abatement equal the marginal benefits of pollution abatement,

a. any further reductions in pollution will continue to increase net social benefits.
b. then firms are likely to increase output.
c. any further reductions in pollution will lower net social benefits.
d. pollution has been entirely eliminated.

4. A downward-sloping marginal benefit curve for pollution abatement means that

a. the costs of pollution decrease as further amounts are abated.

b. the marginal cost of pollution reduction will always exceed the marginal benefit.
c. there are decreasing incremental benefits to be realized from additional increments of pollution
abatement.
d. it is impossible to know the benefits from additional increments of pollution abatement.

5. An upward-sloping marginal cost curve for pollution abatement means that

a. the cost of an extra unit of pollution abatement will increase as the total amount of abatement
rises.
b. additional increments of pollution abatement will yield decreasing benefits.
c. it is impossible to know the benefits from additional increments of pollution reduction.
d. the marginal benefit of pollution reduction will increase with additional increments of pollution
reduction.

6. Zero environmental damage is probably

a. technologically possible but not economically efficient.

b. neither technologically possible nor economically efficient.
c. technologically possible and economically efficient.
d. economically efficient but not technologically possible.

B. Optimal taxes should reflect damage costs

7. A paper mill discharges chemicals into a river that washes the shores of a downstream resort area. The
private cost, social cost, and marginal benefit associated with the production of paper are given by the
following equations: MPC = 5 + Q, MSC = 10 + 2Q, and MB = 35 – 0.5Q. Provide a labelled diagram to
illustrate how the competitive free market will not produce the socially optimal amount of output.
Illustrate the efficiency loss. Illustrate how a per-unit tax could be used to correct this problem.

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8. Robert’s Roses is a plant nursery located in Darlington between a nuclear power plant and a steel mill.
The total cost of producing roses is given by C = 1 + 0.1R2 + 0.5T2 – 0.004E where T is the tons of steel
produced at the mill, E is the amount of electricity produced at the plant and R is the number of roses
grown at the farm. Costs of production at the mill are given by C = T2 and at the power plant are given by C
= 0.0025E2. In competitive markets, roses sell for $2.00, electricity sells for $0.02 and steel sells for $20.
Calculate the system of Pigouvian per-unit taxes/subsidies that would result in the socially optimal levels
of production. No diagram is required.

C. Aggregation of Multiple Sources

9. Automobiles and industrial factories both contribute to air pollution in Toronto. The total cost of abating
automobile emissions is given by C1 = A12 + 8 so that MC1 = 2A1 while the total cost of abating in industry is
C2 = 2A22 + 20 so that MC2 = 4A2. The total benefits from pollution abatement are B = 28A – 0.5A2 + 20 so
that MB = 28 – A where A = A1 + A2 is the total amount of abatement.

a. Calculate the socially optimal amount of abatement activity.

b. How much should each sector abate?

c. Provide a labelled diagram.

10. Consider two firms, A and B, that must engage in pollution abatement. If Firm A has a lower marginal cost
of pollution abatement than Firm B, then

a. reallocating all abatement activity to Firm A will reduce pollution and reduce the total cost of
abatement.
b. regardless of costs, it is equitable for both firms to face the same direct controls on their pollution.
c. reallocating some of Firm B’s abatement activity to Firm A can keep total abatement constant but
reduce the total cost of abatement.
d. reallocating some of Firm A’s abatement activity to Firm B will keep total abatement constant but
will reduce the total cost of abatement.

11. Two firms, A and B, are legally required to reduce their toxic emissions. If Firm A’s marginal cost of
abatement is $5 and Firm B’s marginal cost of abatement is $5,

a. their joint total cost of abatement is at a minimum.

b. Firm B should abate more, and Firm A should abate less.
c. their joint total cost of abatement is at a maximum.
d. Firm A should abate more, and Firm B should abate less.

12. A filthy little town consisting of 3,000 households generates an astonishing 45,000 bags of garbage each
week. This is an average of 15 bags per household! It costs the town $12.00 a bag to collect the garbage
and ship it to a dump in Michigan. An environmental economist has designated 1000 of these households
as residences where abatement will be difficult. Many of these are single persons living in apartments. For
each household in this group, abatement costs are CS = 2rS2. The economist suggests that another group
of 2000 of the households exhibit excellent potential for waste diversion either through re-cycling,
composting or by purchasing products with less packaging. Most of these are family households and the
cost of reducing waste by r bags of garbage is CF = 44 + rF2. Calculate optimal reduction (abatement).
Compute the cost of abatement if each household is assigned equal responsibility. What will happen if
the city charges each household $12 per bag.

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D. Permit Trading
A scheme developed by Professor Dales (U of T Economics)

13. Polluters firm 1 with C1 = 10A1 + A12 and firm 2 with C2 = 20A2 + 0.5A22 have transfer functions E1 = 10 – A1
and E2 = 10 – A2. The government has determined that society should have E = 12 units of pollution.

a. Performance standards require each firm to do units of abatement. Calculate C1 + C2.

b. Each firm is issued E1 = 6 and E2 = 6 permits which would require A1 = 4 and A2 = 4. They are
permitted to trade the permits. Calculate the equilibrium price for these permits. Calculate C1 +
C2. Discuss.

c. What will happen if Green Peace enters the market and purchases 3 permits?

14. Direct pollution controls can be inefficient because, for any given amount of pollution reduction, they

a. create new pollution as they eliminate existing pollution.

b. take into account differing marginal costs among firms.
c. cost too much to enforce.
d. do not minimize the total cost of pollution abatement.

15. Automobile emissions standards are an example of

a. direct pollution controls.

b. a market-based environmental policy.
c. tradable emissions standards.
d. emissions taxes

16. If emissions permits are traded freely between profit-maximizing firms in the private market,

a. all firms will use identical pollution abatement technologies.

b. there will be more than the optimal amount of pollution.
c. each firm will face identical costs of pollution abatement.
d. marginal abatement costs will be equalized across firms.

17. Economists often argue that a system of tradable pollution permits is cost-effective because

a. firms facing a high marginal cost of abatement will not abate at all.
b. firms facing a low marginal cost of abatement will not abate at all.
c. firms will choose their abatement so that their marginal cost of abatement equals the price of a
permit, which is the same for all firms.
d. firms facing a marginal cost of abatement lower than the permit price will not abate at all.

18. Consider a coal-fired electric-power plant that is operating under a cap-and trade-system. If its marginal
cost of pollution abatement is $5 per unit and the price of the permit is $3 per unit, this firm will

a. buy permits and abate less pollution.

b. not abate at all.
c. buy permits and abate more pollution.
d. sell permits and abate more pollution.

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TUTORIAL 6
1. A firm operates in a perfectly competitive market and receives a price $20 for its output. The marginal cost
of production is given by MC = 4Q. A government study has found that the production process creates
pollution and measures the social marginal cost of production at MSC = 5Q.

a. Provide a fully labeled diagram that shows the private profit maximizing choice of output and the
socially optimal choice of output.

b. Calculate the per- unit Pigouvian tax required to achieve the social optimum. Show the impact of
the tax on the same diagram.

2. Healthy Acres Spa sells spa weekends under competitive conditions at a price of $200 per visit. In an
adjacent property a farmer opens a Sammy’s Shrooms, a mushroom farm with total cost function C2 =
2q22 . Sammy sells output competitively for $80 an ounce. Unfortunately, the smell from the Sammy’s
farm creates problems for Healthy Acres increasing the spas cost so they have a total cost function of C1
= 4q12 + q22 + 20q2.

a. Demonstrate that this externality problem could be solved by a merger.

b. Demonstrate that the non-cooperative solution results in an overproduction of mushrooms.

c. Demonstrate that this externality problem could be solved using a Pigouvian tax.

3. An industry consists of two polluting firms with abatement costs C1 = 2A12 and C2 = A22 so MCA1 = 4A1 and
MCA2 = 2A2. The current environmental standards require the firms to perform A1 = 30 and A2 = 30 units of
abatement.

a. Provide a labelled diagram for each firm showing the marginal costs of abatement. Illustrate and
quantify the standards and permit equilibria.

b. Permits will trade at a price of __________ dollars per unit of abatement. T

c. The total costs of abatement in this industry will fall by __________ dollars with the introduction of
the permit trading plan.

4. Five-year-old twins Frank and Gordon create Toy Pollution; their room is a mess. In this case, abatement
is the time they spend cleaning up. Abatement costs are CF = 2AF2 + 20 and CG = AG2 + 8. Their sister, 10-
year-old Linda gets benefits of cleanup are given by B = 14A – 0.5A2 + 20. If the boys don’t clean up, she
has to.

a. Calculate optimal abatement.

b. Allocate abatement based on performance standards that equalize responsibility. Compute the
total cost of compliance.

c. Allocate abatement based on equal MCAs. Compute the total cost of compliance.

d. Propose a payment mechanism (one boy pays the other) so that this allocation of cleanup time
would be mutually agreeable. Explain why your mechanism would be mutually agreeable.

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