Question

Uppose United States and Canada decide to sign the Kyoto Protocol, by which they commit to reduce their greenhouse gas emissions to a target level of 200 tons of CO2 each. The marginal cost in dollars) of abatement for the US is: MCus = 25 + 1*A, where A represents the quantity (in tons) of CO2 that gets reduced (i.e., abated). Canada is less efficient at reducing emissions, and faces a marginal cost in dollars) of abatement given by: MCCA = 15+ (3/2)*A. Now, assume that the market price per ton of CO2 is 75 dollars, and that one pollution allowance traded on this market corresponds to one ton of CO2. Thus, any polluting firm can purchase a permit to emit 1 ton of CO2 at the rate of 75 dollars. Both countries take this price as given.

A. Does the US gain from trading (i.e., buying/selling) permits on the world carbon trading market? Calculate the gains/losses from participating in the market for pollution permits. Indicate on the MC graph previously drawn the area corresponding to the calculated gains/losses from trade.

B.How about Canada, does it gain from trading (i.e., buying/selling) permits on the world carbon trading market? Calculate the gains/losses from participating in the market for pollution permits. Indicate on the MC graph previously drawn the area corresponding to the calculated gains/losses.

C. Draw an Environmental Kuznets Curve carefully labeling the intercepts. Based on the discussion in this problem, where on the curve would you locate the U.S.? How about Canada?

Answer 1

Both the United States and Canada would gain from selling permits in the carbon trading market, as their marginal costs of abatement are lower than the price of CO2 emissions permits. The US, with higher costs for additional abatement, is likely on the descending part of the Environmental Kuznets Curve. Canada could be on the ascending part due to its less efficient abatement processes.

Step-by-step explanation:

When assessing whether the United States and Canada gain from trading permits in the world carbon trading market, we need to compare the market price of a permit to emit one ton of CO2 ($75) to the countries' respective marginal costs of abatement. For the United States, the calculated marginal cost is MCUS = 25 + 1*A. If the United States abates one ton of emissions (A=1), their cost would be $26, which is lower than the market price of $75, hence the US can gain from selling permits as it is cheaper for them to reduce emissions than pay for permits.

On the other hand, Canada's marginal cost is MCCA = 15 + (3/2)*A. If Canada abates one ton of emissions, the cost would be $16.50, again lower than the market price of $75. This implies that Canada would also gain from selling permits since it is less costly for them to reduce emissions compared to buying permits. Both countries can reduce emissions until their marginal cost equals the market price to maximize gains (sell permits).

The Environmental Kuznets Curve illustrates that as a country's economic development progresses, environmental degradation increases until a certain income level is reached, thereafter it declines. The US, being a developed country with higher costs for additional abatement, would likely be on the descending part of the curve. Canada, while also developed, faces higher abatement costs and thus could be on the ascending part of the curve as it has less efficiency in abating emissions compared to the US.