4. Lecture 3 - Policy instruments II

Question 1

Name 2 goods/services for which one can design a cap and trade system.

Answer 1

• Emissions
• Catching fish
• Harvesting trees
• Water extraction
• Access to a congested area

Question 2

Name 1 main uncertainty in implementing a command and control policy for reducing a negative externality.

Answer 2

• Optimal level op mitigation
• Hetereogeinity of marginal mitigation curves across firms
• Degree of inefficiency

Question 3

Name 1 main uncertainty in implementing an optimal environmental tax for reducing a negative externality.

Answer 3

• Determining optimal tax level
• Optimal tax may be space- and time- dependent
• Administration costs
• Distributional effects

Question 4

Name 1 main uncertainty in implementing an optimal subsidy for increasing a positive externality.

Answer 4

• Size of positive externality
• Determining optimal subsidy level
• Windfall profits

Question 5

Name 4 types of subsidies

Answer 5

• R&D subsidies
• Pollution reduction subsidies
• Consumer subsidy
• Tax exemptions

Question 6

What are “perverse subsidies”?

Answer 6

Subsidies on polluting energy, which indirectly raise the relative cost of renewable energy.

Question 6

Name a pro and a con of producers subsidies

Answer 6

Pro:

• Limited transaction costs
• Incentive to comply

Con:

• The polluter is paid
• Dynamic effects (profit increase creates an influx of new polluters)
• Difficult to end
• Lead to larger than optimal production and related polltion

Question 7

What is the difference between a static market and a dynamic market?

Answer 7

In a static market, no shifts of the supply/demand curves happen, only a shift on the curve.

In dynamic markets, shift on and of the curve are possible.

Question 8

What is the basic principle of the Coase Theorem?

Answer 8

Under certain circumstances, voluntary negotiations will lead to efficiency.

The initial allocation of rights does not matter for efficiency.

Question 9

What are the 3 conditions needed for the Coase thereom?

Answer 9

1. Well-defined property rights
2. Tradable property rights
3. Low/no transaction costs

Question 10

Why is it difficult to set the emission cap at the optimal level?

Answer 10

Vested (political) interests and grandfathering.

Question 10

Name 3 elements of a cap and trade system.

Answer 10

1. Ceiling for total permits
2. Free trade in permits
3. Fines if output exceeds permits

Question 11

Why may a perverse subsidy cause an increase in DWL?

Answer 11

Because of the subsidy, the equilibrium production will increase.

This will lead to an increase in the negative externality (e.g. more pollution).

Thus the DWL increases