A2.04.03: Carbon Taxes

Question 1

Define carbon taxes

Answer 1

A tax on producers emitting greenhouse gases and it sets a price on the carbon content forcing producers to pay for each tone of emissions which raises their costs of production and should reduce supply

Question 2

What stages are there to the carbon tax diagram (also state the labels of the x and y axis) using the market for electricity generated by coal-fired power-stations

Answer 2

• X axis: Quantity
• Y axis: price/costs/benefits ($)
• Pe and Qe (Before carbon tax)
• Popt1 and Qopt 1 (After carbon tax)
• Popt2 and Qopt2 (Effects of Carbon tax)

Question 3

Explain Pe and Qe (Before carbon tax) on the diagram using the market for electricity generated by coal-fired power-stations

Answer 3

• Negative externality of production as MSC>MPC
• Overproduction/consumption of electricity generated by burning coal
• society would benefit from less

Question 4

3 advantages of carbon tax

Answer 4

• Extra tax revenue; can be used to fund schemes that decrease CO2 emissions
• Makes polluter pay for their damage
• If the carbon tax is set sufficiently high, this creates strong incentives for clean energy investment to lower CO2 emissions

Question 4

Explain Popt1 and Qopt1 (After carbon tax) on the diagram using the market for electricity generated by coal-fired power-stations

Answer 4

• social optimum reached
• MSC1 = MPC2 + Tax
• Price increases from Pe to Popt1, Quantity decreases from Qe to Qopt1
• The carbon tax incentivises the firm to find ways to reducing their CO2 emissions; investing in more green technology may be a cheaper option than incurring the losses by the tax
• In the long-run, CO2 emissions decrease hence, the Carbon tax becomes more lax and decreases too

Question 5

5 disadvantages of carbon tax

Answer 5

• increases costs of production ; business profits diminish and has a potential to harm jobs
• difficult to measure CO2 emissions; this makes it tough for governments to set the right level for the Carbon tax
• Regressive nature of taxes; there will be greater impacts on low-income households
• Businesses may leave to country; to move to a country with low Carbon taxes or none at all hence, global emissions do not change
• If PED is low, there may be a need for a very high Carbon tax; governments incur opportunity costs

Question 5

Explain Popt2 and Qopt2 (Effects of carbon tax) not the diagram using the market for electricity generated by coal-fired power-stations

Answer 5

• costs of production for firms decreases
• MSC2=MPC1 + Tax
• Price decreases Popt1 to Popt2, Quantity increases from Qopt1 to Qopt2
• Therefore, carbon taxes are effective as output increases and costs of production for firms decreases