In: Economics
a) Consider a perfectly competitive market. Suppose that
production causes pollution as a by-product. Explain why markets
fail to generate an efficient outcome in the presence of pollution,
and how an environmental tax can restore efficiency. What
difference, if any, does it make for the optimal environmental
policy whether the firms have abatement technologies available or
not? Use relevant diagrams to illustrate your arguments.
b) Now suppose that a single firm supplies this market.
Characterise the optimal environmental policy in the case of a
monopoly. Does it now make a difference whether an abatement
technology is available or not. Use again relevant diagrams to
illustrate your arguments.
a)
In the presence of negative externalities, firms tend to overproduce. Overproduction affect the environment negatively. Social marginal cost (SMC) is greater than the Private Marginal Cost (PMC), hence, firm does not take into account the social marginal cost while deciding level of output.
firm may go for the better technology if fear of carbon tax looms.
Imposition of tax by the government would make firm to internalise the external cost in its production decision and it would reduce the output level. Following is diagram:
In above diagram, imposition of tax shifts the MC or supply curve to left thereby reducing output to optimal level. Tax is equal to Marginal external effect.
b)
Output in monopoly competition tends to be less than the competitive market. Hence, to some extent, it is able to reduce the negative effect of output marginally. Government can impose tax to reduce the output to optimal level.
Firm would go for clean technology if it profitable. Firms would analyze it base on the amount of tax being imposed.
Following is diagram:
In above diagram, after imposition tax, MC increases hence output also falls from Qm to Qs.