California decides to regulate carbon emissions and calculates the marginal cost of abatement and marginal benefit of abatement as follows:
MCA = 30 + Q, MBA = 150 – 3Q.
(a) (6 points) If California wants to maximize welfare by setting a tax, what tax should it set?
(b) (4 points) An alternative to the “market-based” tax in part (a), is command-and-control regulation. Briefly explain the drawback(s) of a “command-and-control” approach relative to the tax in part (a)?
(c) (4 points) Suppose carbon emissions have impacts outside of California but California only takes into account the impacts inside California. If California were to take into account all the impacts, explain whether the MCA or MBA curves would shift inwards or outwards and whether the tax in part (a) would be too high or too low relative to the welfare-maximizing tax.
(d) (8 points) Suppose California misses the optimal tax in part (a) and sets a tax of t = 70. How much abatement will occur? What will be the deadweight loss?
Sample Solution
