Upcoming in Class

1. Upcoming in Class Homework #1 Due Sept 4th 1st Group Quiz - Monday Sept. 9th Writing Assignment Due Oct. 23rd

2. Automobile Marketwith External Costs

3. Dealing with Externalities • The Pursuit of Efficiency • Legislative and Executive Regulation • Direct Control – Quota • Cap and Trade • Pigovian Tax – “polluter pays principle”

4. Pigovian Tax Problem 1 • Suppose the demand function for gasoline is • Pd = 6.5 - 0.5 Q where Q represents billions of gallons of gasoline. • Suppose the supply function for gasoline is based on the firms’ marginal private costs and equals • Ps=Q • What is the market equilibrium level of output and price?

5. Pigovian Tax Problem 1 • Suppose the government’s EPA determines the socially optimal amount of gasoline use is actually 3 billion gallons of gasoline. • To reach this socially optimal quantity, the government is going to implement a per unit tax on the consumption of gasoline. The tax revenue from which will go to protecting the environment as determined by the EPA. • What should the tax amount be? • What price will the consumers pay? • What price will the sellers receive? • How much money will go to protecting the environment?

6. Pigovian Tax Caveats Setting the optimal tax is difficult because we might not really know what the true cost of the externality is.

7. Pigovian Tax Problem 2 Suppose that the demand schedule for new automobiles in the United States is given by: Pd= 100-0.09 Q Where Pd is the price of new vehicles in thousands of dollars and Q is the quantity demanded per month in 100s of thousands. Assume the supply is: Ps=4+0.03 Q Where Ps is the price and Q is the quantity sold per month.

8. Pigovian Tax Problem 2 Solve for the market equilibrium price and quantity. Calculate the producer and consumer surplus under the market equilibrium.

9. Pigovian Tax Problem 2 We also need to consider the negative externality costs. Suppose the externality cost of each automobile is $6,000. What is the total external cost?

10. Pigovian Tax Problem 2 Consider the net social benefits if we were to institute a tax on automobiles that fully internalize the externality. What should be the cost of the tax? Suppose tax is instead set at $9,000. What would be the market equilibrium under the tax? What would be the price paid by consumers? What would be the price received by sellers? How much is generated in tax revenue? What are net benefits?

11. Pigovian Tax Problem 2 What is the loss in net benefits from setting a tax too high?

12. Pigovian Tax Caveats Sometimes it’s unclear where exactly the pollution is coming from (i.e. nonpoint-source pollution) Not always clear who should pay. (Sturges v Bridgman)

13. Coase Theorem • If property rights are well-defined, and no significant transaction costs exist, an efficient allocation of resources will result even with externalities.

14. Coase Theorem Problem • A chemical factory is situated next to a farm. Airborne emissions from the chemical factory damage crops on the farm. The marginal benefits of emissions to the factory and the marginal costs of damage to the farmer are as follows • MB= 360 – 0.4 Q and MC=90+0.2Q • From an economic viewpoint, what is the best solution to this environmental conflict of interest? • How might this solution be achieved?

15. Upcoming in Class Homework #1 Due Sept 4th 1st Group Quiz - Monday Sept. 9th Writing Assignment Due Oct. 23rd