Quiz 2

Question 1

In the last part of the subsidies lecture we discussed the potential effects of a an R&D subsidy. However, we did not analyse welfare effects of such a subsidy, and of the additional welfare effects of a consumer subsidy. What elements do these welfare effects depend on?

Answer 1

They depend on a lot of things, but most important ones are:

• R&D subsidy costs, consumer subsidies required
• Firm innovation costs
• Changes in consumer and producer surplus
• Increase in positive externality (shape of marginal external benefits curve)

Question 2

Below is the graph on negotiations that was also used in the lecture. Assume ownership of pollution rights lies with the company, and that there is negotiation between community and company about reducing production and thereby pollution. What is the negotiation space for this negotiation (i.e. what is the range of the amount of money that will come out of this negotiation)?

Answer 2

Reference point is full production and pollution, until the point where marginal benefits of production are zero. Minimum WTA of company is D, maximum WTP of community is D+E+F, so negotiation space is between D and D+E+F.

Question 3

Now assume that ownership of pollution rights lies with the community, and that there is negotiation between community and company about incresing production and thereby pollution. What is the negotiation space for this negotiation (i.e. what is the range of the amount of money that will come out of this negotiation)?

Answer 3

Reference point is no production and therefore no pollution. Minimum WTA of community is C, maximum WTP of company is A+B+C, so negotiation space is between C and A+B+C.

Question 4

Think of and write down some examples of goods/services for which you could design a cap&trade system.

Answer 4

Emissions (local/global)
Catching fish
Harvesting trees
Water extraction
Acces to a congested area (recreation areas, highways, …)

Question 5

When designing a policy instrument in reality, what in your assessment are some of the main uncertainties when implementing:

a command and control policy (for reducing a negative externality)?
an optimal environmental tax (for reducing a negative externality)?
an optimal subsidy (for increasing a positive externality)?

Answer 5

Command and control

Optimal level of mitigation
Heterogeneity of marginal mitigation cost curves across firms
Degree of inefficiency

Optimal tax

Determining optimal tax level (think of what you need to know for this)
Optimal tax may be space- and time-dependent (e.g. road taxes)
Administration costs (consequence: taxes not on end-users but on intermediate products)
Distributional effects (who gains and who loses)

Optimal subsidy

Size of positive externality (with a negative externality one may know the size of the externality, more difficult with positive externalities perhaps because some parts of this externality are unknown by definition)
Determining optimal subsidy level (think of what you need to know for this)
Windfall profits – how many firms would invest without subsidy?