Question

Q4 i) Under first-degree price discrimination, a monopolist produces the efficient output. Is this true or false? Explain using an appropriate diagram.

ii) Several generators pollute the environment by emitting carbon dioxide. Generators have different costs of reducing carbon emissions. The government wants to put a cap on total emissions. Putting a cap on each generator is more efficient compared to issuing tradeable emissions permits to each generator. Is this true or false? Explain your answer.

Answer 1

4. 1) True.

if a monopolist can engage in first degree price discrimination it will charge each consumer the maximum they are willing to pay according to the demand curve. Thus the monopolist will produce as long as the Demand curve itself is above the Marginal cost curve and will stop when they both become equal. In this case the consumer surplus is 0 as all the money the consumers are willing to pay will go into producer surplus, but the output in quantity achieved on the x axis will be the same as the efficient output(Deterrmined by when the demand curve meets the Marginal cost curve.)

2) False.

Tradeable permits to each generator is more efficient. In this case since the generators have different costs of reducing carbon emissions, if they are given the same cap on each generator, some of the generators will have a higher cost of reducing emissions compared to others, and thus the overall cost will be higher. However if tradeable permits are allowed, generators with lower costs of cutting down emissions can trade the permit to other generators that have a higher cost on reducing emissions for a profit. This will allow the generator with higher costs to buy permit and experience less losses meanwhile the one with lower cost of reducing emissions can sell its permits for a profit covering for the cost of reducing emissions. This lowers the total cost of all generators while the total emission remains the same as before.

Hope it’s clear. Do ask for any clarifications if required.