Correcting for negative externalities - Taxes versus tradable permits

Power stations emit sulfur dioxide as a waste product. This generates a cost to society that is not paid for by the firm; therefore, pollution is a negative externality of power production. Suppose the U.S. government wants to correct this market failure by getting firms to internalize the cost of pollution. In order for this to be done, the government can charge firms for pollution rights(the right to emit a given quantity of sulfur dioxide). The following graph shows the daily demand for pollution rights.

Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph.

Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly.

PRICE (Dollars per ton) 90 81 72 63 54 45 36 27 0 35 Demand + 70 105 140 175 210 245 280 315 350 QUANTITY (Millions of tons) Graph Input Tool Daily Demand for Pollution Rights [1Price 9 (Dollars per ton) Quantity Demanded L (Millions of tons) Adjusted PRICE (Dollars per ton) 20 81 72 63 54 45 36 27 Demand + I I I I I I 0 35 70 105 140 175 210 245 280 315 350 QUANTITY (Millions of tons) Graph Input Tool Daily Demand for Pollution Rights |:| Price a5 (Dollars per ton) Quantity Demanded 178 (Millions of tons) One way governments can charge firms for pollution rights is by imposing a per-unit tax on emissions. A tax (or price in this case) of per ton of sulfur dioxide emitted will achieve the desired level of pollution. Now suppose the U.S. government does not know the demand curve for pollution and, therefore, cannot determine the optimal tax to achieve the desired level of pollution. Instead, it auctions off pollution permits. Each permit entitles its owner to emit one ton of sulfur dioxide per day. To achieve the socially optimal quantity of pollution, the government auctions off 175 million pollution permits. Given this quantity of permits, the price for each permit in the market for pollution rights will be An environmental study conducted in a particular city suggests that if a chemical plant emits more than 30 million tons of chemicals each year, the water supply will become contaminated beyond the point where filtration techniques can make it safe for drinking. If this is all the information the government has, which solution to reduce pollution is appropriate? Check all that apply. Pollution taxes Pollution permits