Question

Suppose that the marginal abatement cost function and the marginal damage functtion for an industry are given as follows:

MAC= 100-0.8e

MD= 0.2e
Suppose instead that the government implements sufficiently strict liability laws where polluting firms are fully financially liable for any damages their emissions cause. Under this scenario, what it the expected level of emissions? Explain.

Answer 1

A firm will abate pollution up to the point where the marginal cost of doing so is just below the pollution tax. In this scenario, with a pollution tax of $1,000 for every 10 pounds, the firm will abate 30 pounds and pay the tax for any further emissions, as abating more than that would cost more than the tax.

Step-by-step explanation:

The question involves understanding the economic decision-making of firms when faced with environmental regulations, specifically pollution taxes. Firms compare the marginal abatement costs (MAC) of reducing pollution with the tax imposed on emissions. If the marginal abatement cost of reducing an increment of pollution is lower than the pollution tax, the firm will choose to abate. Conversely, if the MAC exceeds the tax, the firm will opt to pay the tax rather than abate further. Given the scenario where the pollution tax is $1,000 for every 10 pounds of particulate matter, a firm will abate pollution up to the point where the MAC is just below the tax, which typically represents reducing emissions by 30 pounds, because the abatement cost is lower than $1,000 for the first three increments (10 pounds each at $300, $500, and $900 respectively) and exceeds the tax for subsequent increments.

Ultimately, the firm will abate 30 pounds of pollution and pay the tax on any additional emissions, which is the cost-effective strategy, as the fourth increment of 10 pounds would cost $1,500 to abate, which is higher than the tax. This analysis allows the firm to minimize its total costs while complying with environmental regulations.