Question

. The largest human contributor to climate change is carbon dioxide emissions. If using (i.e. burning) fossil fuels results in an external cost due to the resulting carbon dioxide emissions:

a. Explain in two sentences why, in the absence of regulation, fossil fuels will be overused.

b. Electricity is typically provided to households by just a single provider. Show in a single graph why, in the absence of regulation, too little electricity will be sold if we do not consider externalities..

c. Electricity markets are in practice tightly regulated, and the price at which electricity is sold typically is just about exactly the producer’s opportunity cost (i.e. price equals cost of production plus a modest/ typical profit for the firm.) Show using a graph that, if we do consider externalities, too much electricity is produced. Notes: fossil fuels are used to produce electricity; include MPC, MSC, and externality in your graph.  

d. The largest obstacle to moving to more renewable electricity (e.g. solar and wind) is storage. Suppose we wanted to spur faster development of battery storage technologies

i. Starting from the idea of negative externalites, justify using a targeted tax to accomplish this. In your answer (about 3 sentences), identify specifically what should be taxed, why this would be efficient, and the incentive it would create in the battery market.

ii. Starting from the idea of technological spillovers, justify using a targeted subsidy to accomplish this. In your answer (about 3 sentences), identify specifically what should be subsidized and why this would be efficient.

iii. Starting from the idea of technological spillovers, justify using a strengthened property rights approach to accomplish this. In your answer (about 3 sentences), identify specifically what should receive strengthened property rights, and the legal mechanisms (just the key terms are all I’m looking for).

Answer 1

a. In the absence of regulation there will be the problem of tragedy of commons. Without proper regulations, the negative externality due to the buring fossil fuel will have no cost on the person who burns it, and thereby it leads to overuse.

b. As electricity is normally sold by a single producer, it is considered as a monopoly. Thus the quantity of electricity that will be sold will be lower than the maximum amount of electricity that they can sell. This is because electricity will be sold at a higher price and too little electricity will be sold.