Question

Suppose the marginal damage of carbon pollution is constant, equal $40/ton. If you create a carbon tax, what should be its value so that we maximize social welfare?

Suppose the marginal cost of carbon abatement (reducing pollution) is given by P = 10 + Q, with P measured in $/ton and Q measured in tons. If we want to create a cap and trade program that is equivalent to the tax above (maximizing social welfare), how many tons (Q) should be abated by this policy?

Answer 1

1) Given that the marginal damage of carbon pollution is constant, equal $40/ton.

To create a carbon tax, its value so that we maximize social welfare, should be equal to the external damage caused.

Therefore, the tax should be set at $40/ton

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2) Given that the marginal cost of carbon abatement (reducing pollution) is given by P = 10 + Q

To create a cap and trade program that maximizes social welfare, set 10 + Q = 40

Thus, Q = 30 tons

This policy will abate 30 tons of pollution