Question

What is the effect of a carbon tax on the equilibrium number of flights? Would an equilibrium change be caused by a shift in demand? Would the imposed tax on carbon emission control the pollution generating source? Why would countries with airlines flying to and from Europe retaliate against the EU's imposition of a tax on carbon emissions?

Answer 1

1) A tax would lower the equilibrium number of flights, due to consumers and suppliers having to pay the additional costs from the tax. This would not be caused by a shift in demand - the supply and demand curves would remain the same, but the amount of the tax would drive a "wedge" between their prices - meaning consumers would now pay more and suppliers would receive less - so this will lower the equilibrium number.

2) The tax would decrease the number of flights, which generates pollution. However, pollution would not totally go away, and without knowing the social costs of pollution, we cannot be sure if the tax would reduce pollution to an efficient level. Pollution is controlled in an economically efficient way when the social cost of pollution is equal to the amount of tax. In essence, social cost = social benefit (tax revenue). In short, it would reduce carbon emission, but we cannot be sure from the information here if that would be in an efficient way or not.

3) Other countries would retaliate because the EU is taxing flights into their country - so essentially, businesses outside the EU are paying the tax to help mitigate pollution in the country, but they are not receiving any of the benefits of the tax since they are not operating their business within the EU. Essentially, other countries will not like providing revenue to the EU for which they will never experience any benefits, which will cause them to enact their own taxes as well.