Consider the model from section 5.4, where the number of firms is endogenous. Derive the comparative static results for emission taxes, auctioned permits, and absolute standards. That is, determine the direction of change for x, e, J, p, X, and E when the level of each policy variable is marginally changed.

Data from section 5.4

Transcribed Image Text:

Our discussion thus far has assumed that the number of firms is fixed at J, and therefore it has been limited to short run analysis. In the long run, of course, firms may enter and exit the market, and this may impact the optimality properties of the environmental policy instruments we have studied thus far. Basic microeconomic theory demonstrates that under perfect competition, technologically identical firms enter or exit the market until profits are driven to zero, and all firms produce at the minimum point on their long run average cost curve. Furthermore, if firms have non-zero fixed costs and strictly convex cost functions, the socially optimal number of firms is endogenously determined. In what follows we maintain these traditional assumptions while considering the long run impact of environmental policy on a competitive industry. This is a departure from our usual starting off assumption that firms are asymmetric. It is necessary because firm heterogeneity is inconsistent with the long run zero profit condition, in the sense that it is not possible for firms with different minimum average costs to be in the market at the same time, since only firms operating at the smallest minimum cost can survive. To avoid the awkwardness of asymmetric firms with identical minimum average costs, we proceed with the identical firm assumption.