3. MSC = MPC + MEC MPC Output of Crude Oil Qi Qo Using the diagram above, answer
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3. MSC = MPC + MEC MPC Output of Crude Oil Qi Qo Using the diagram above, answer the following questions: a. Assuming no form of government intervention, what price and quantity of oil would be produced in a competitive private market? b. If we included the marginal external costs of COze or GHG emissions, what price If we included the marginal external costs of CO2e or GHG emissions, what price and quantity of crude oil would be socially optimal? c. What carbon tax or price would achieve the socially optimal price and quantity of crude oil output? Why? d. What would be the net gain in social welfare from imposition of tax? Who would capture the "rents" from the tax? Why? Based on class discussion and the text, are there other (public or private) options that could be used to correct this misallocation of resources? Would these options be as feasible and as efficient? Why or why not? e. BExplanation / Answer
a) when there is no government intervention, firms will produce at the intersection point of MB and MPC line. This point will allow firms to produce more and sell more. Firms marginal private cost is ess than marginal social cost and it allows firms to appropriate more profit.
b) Remember, marginal private cost includes cost of manufacturing alone wherewas marginal social cost includes cost inflicted on the society due to say pollution produced by firms. Pollution causes several health risks and is therefore a cost to the society. If this cost is also added to the private cost of firms, its overall cost increases. The new equilibrium will be reduced quantity at Q1 and price P1.
c) Tax at the rate of Marginal external cost at each level of output would achieve socially optimal price and quantity. This is because now firms will also consider the cost of pollution (in the form of tax) in its production function and thereby reduce output and increased price. It is called as Pigouvian tax.
“A Pigouvian tax is an emission fee exactly equal to the aggregate marginal damage caused by the emissions at the efficient level of pollution.”
d) society would gain from less pollution without paying for pure air. Rent i.e. would go to the government as firms would pay the tax to the fovernment not the society memebrs affected by pollution. The idea is to induce firms to produce less pollution and impose tax on them for producing pollutants.
e) Yes there are other methods as well to achieve same optimal level of output. Coase theorem and permit system are other effective ways to curb pollution. Though each one of them has their respective advantages and disadvantages.
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