Assume that there is uncertainty about the value of pollution control as a result of, for instance, uncertainty about the costs of pollution. Draw two different "demand curves" (or benefit curves) for pollution, showing the marginal benefit of reducing pollution by one more unit decreasing as the level of pollution reduction increases. Assume that the marginal cost of pollution abatement increases as the level of pollution abatement increases.
a) Assume the government can regulate the amount of pollution control after it knows what the benefits are. Show the level of pollution control will be in this situation. Explain.
b) Assume the government can impose a tax on pollution after it knows what the benefits are. Show what the level of tax (or fine) will be in each situation. Is there any difference between regulations and fines in these circumstances? Explain
c) Now assume that the government must set the level of allowable pollution before it knows what the benefits are. There is a cost to society due to allocative inefficiency. How do you minimize some of these two social welfare losses? Explain