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Assume that chemical firms generate pollution. A study found that the firms’ pollution is
negatively affecting the environment. The study was read by several politicians and they have
requested to the government to impose a tax. Politicians expect to observe a decrease in the
environmental damage (specifically, eliminate the deadweight loss). Please find the optimal tax
that the government should impose in this chemical market.
Emission Fee – Negative Externality
MCS
Government
Revenue
10
MCP=S
With Tax (2)
8
TAX=8-7=1
Without Tax (1)
7.5
7
MCE
5
Demand
1
2
2.5
10
Net Social Benefit (NSB)
Consumer Surplus (CS) + Producer Surplus (PS) - Cost of
with Tax=
+GR
Externality (CE)
Positive Externalities MSB>MPB
•
How might public policy correct for the economic inefficiency resulting from underproduction
with a positive externality?
Price
Eq. With
Subsidy
MSB at Q1
Optimal
Subsidy
Per Unit
Supply (MC)
Government
cost from
Subsidy
PS
P1
MBS=MPB+MBE
P*
MBP
MBE
Q1
Market Quantity
Q*
Net Social Benefit = CS + PS+ BE+ Government Cost
Common Property (Congestion Toll)
•
Price
MCS
8
Optimal
Peak Toll
MCP
5.75
MCE
5
4
Peak-Demand
Off-Demand
Q1
MCE=MCS
No Congestion
Q2
Q3
Q4
Q5
Quantity
Exercise - Positive Externality
• The production of Honey usually generates a side effect or
positive externality. That is, the pollination of surrounding
crops by the bees. In some cases, the value generated by
the pollination may be more important than the value of
the harvested honey. In order to promote this activity, the
government sets a subsidy for the honey industry. Assume
that the market demand is:
• Demand (MBP): P=10-q
• MBE=5-1/2q
• MC=q
• Determine the government cost from the subsidy and the
CS and Producer surplus (before and after subsidy)
Examples
Gasoline Taxes (cents per gallon)
July 2012 - API
• In average, state and local taxes add 31.1 cents to gasoline for a total US
average fuel tax of 49.5 cents per gallon for gas (April 2012).
Subsidies
• Ethanol subsidies: Since 1980 the ethanol industry was
awarded an estimated US$45 billion in subsidies. The U.S.
Congress did not extend the tariff and the tax credit, allowing
both to end on December 31, 2011.
• Fossil-Fuel subsidies: The Environmental Law Institute (2009)
estimated that subsidies to fossil-fuel based sources
amounted to approximately $72 billion over 2002-2008 period
and subsidies to renewable fuel sources totaled $29 billion.
[Annual tax deductions]
• Higher Education subsidies: The Department of Education
spends about $30 billion a year on subsidies for higher
education. The bulk of that funding goes toward student aid
programs. [Budget of the U.S. Government, Fiscal Year 2009]