ECN 275/375 Natural resource and environmental economics 11:00-14:00 April 11, 2018

Transcription

1 Course responsible: Page 1 of 5 ECN 275/375 Natural resource and environmental economics 11:00-14:00 April 11, 2018 A1: No books except English dictionary, no other aiding tools. This exam consists of 5 questions, for a total score of 100 points. All questions are to be answered. You may answer in English or Norwegian. Question 1 (20 points) Non-tradeable emission permits (also called fixed permits) are generally not cost effective. (a) Show graphically why non-tradeable permits generally are not cost effective. (10 points) Answer: Two different marginal abatement cost curves, i.e., MAC L (M) MAC H (M), but with the same constraint (required reduction) on emissions. To keep the graph simple I have assumed the two firms have the same initial emission level, i.e., M H 0 =M L 0 = M. As one can see from the graph MAC L ( M) MAC H ( M). This is inconsistent with definition of cost effectiveness in this case that would require MAC L ( M)=MAC H ( M). (b) In your graph from (a), introduce an emission tax that gives approximately the same total emissions reductions, and explain why this tax yields a cost effective allocation in emissions. (5 points) Answer: The tax t gives MAC L (M L ')=MAC H (M H ')=t '. Hence the condition for cost effectiveness is met as the marginal abatement costs for the two firms are the same evaluated at the chosen emission levels, M L ' and M H ' respectively. (c) In your graph from (a), show the cost savings from society s perspective of introducing the tax. Briefly explain how you arrive to this result. (5 points) Answer: The societal cost savings are the sum of the yellow colored areas H and L. For firm H (the high abatement cost firm), the cost savings from being able to increase emissions from M to M H ' equal areas A + B + H. For firm L (the low abatement cost firm), the cost increases of reducing emissions from M to M L ' equal areas D + E. Assuming the distance between M and M L ' equals the distance between M and M H ', the area D + E + L equals the area A + B. Hence, we are left with cost savings H + L. Question 2 (20 points)

2 Course responsible: Page 2 of 5 Commonly, there are two benefits of using environmental taxes or any other incentive compatible revenue creating policy instruments for reducing negative externalities: (i) change in behavior that leads to reduced emissions, and (ii) creation of tax revenues that allows for reducing other distortive taxes (like income taxes) or increased public spending. (a) Which of these two effects are likely to be most important from a welfare economic perspective? Briefly, justify your answer. (10 points) Answer: The first effect that leads to reduced emissions and hence expected gains in environmental quality. The reason for this is as follows: The impacts from the improvement in environmental quality is a direct welfare effect, while the reduction in tax payments is a transfer payment. The real impact of the transfer payment reduction only takes place if they are offset by an equivalent increase in other taxes like income taxes for the government to be able to provide the same level of services to the agents. This is an indirect effect, and indirect effects are usually less than direct effects. Remark: in the tax literature this is referred to as the double dividend (not needed to get full score). (b) Why is the revenue generation from an environmental tax likely to decline over time? (10 points) Answer: An environmental tax is supposed to change behavior. Behavior change (for example through less emissions caused by adoption of cheaper abatement solutions which makes it optimal to reduce emissions further) the tax base gradually erodes as agents learn about less costly ways to decrease their marginal abatement costs. An emission tax (like t') is likely to induce such a change. This is easily demonstrated using a graph, where z denote emissions. Let MAC ' (z) and MAC'' (z) be the old and new MAC. Under the new MAC that emerges from agent adjustments like adoption of new technologies or investment in abatement, the tax revenues are reduced from A+B to A. Question 3 (20 points) Resource allocation mechanisms (RAMs) provide important principles for designing environmental policy. (a) State the three necessary conditions for a RAM to yield predictable outcomes, and explain what the three conditions mean. (5 points) Answer: (i) The participation constraint = it is in the agent s own interest to participate. (ii) Informational viability = the mechanism does not require more information than what is available, and (iii) incentive compatitbility = it is in the agent s own interest to behave in a manner consistent with the principal s (regulator s) intents for agent behavior.

3 Course responsible: Page 3 of 5 (b) Why are predictable outcomes in economic policy so important? Briefly justify your anwer. (5 points) Answer: Without a predictable outcome, there is no valid base for making welfare assessments, i.e., being able to judge how a policy improves welfare. The basis becomes highly uncertain as one does not know ex ante how agents will respond, and hence what the resulting economic equilibria will be. This uncertainty borders lack of knowledge, which is the most difficult type of uncertainty to deal with in economic assessments. (c) The RAM framework is a development from principal-agent (PA) models. Explain the linkages between adverse selection and moral hazard in PA-models and the conditions in RAMs. Provide a classical example from the literature for each of the situations: adverse selection and moral hazard to illustrate your points, and then examples from environmental policy. (10 points) Answer: The participation constraint in RAMs is primarily linked towards adverse selection (uncertain or unobservable agent types or characteristics). Adverse selection issues are commonly dealt with by offering agents a menu of choices (some times only with one menu item), and the agent s choice of menu item (in the classical PA-literature on insurance, the type of insurance policy chosen), reveals the agent s type. Examples of adverse selection in environmental economics include high and low cost agents for supplying habitat management for biodiversity or for reducing emissions. The incentive compatibility condition in RAMs is primarily linked to moral hazard (difficulties for the regulator observing agent actions). Classical examples in the insurance literature relate to incomplete reimbursement for accidents or losses of property to provide some (partial) incentives for showing care. In environmental economics, examples include cases where the regulator cannot fully observe agent actions or the effects of agent actions, like in nonpoint source pollution or efforts undertaken in habitat management. Question 4 (20 points) Consider a logistic growth curve for a fish population, where net biomass as a function of stock size is of the type g(s)=γ S ( 1 S S MAX ), where γ is a growth parameter, S is the stock size, and SMAX is the maximum equilibrium stock size for the fish population. (a) Identify the maximum sustainable yield stock, SMSY, for this fishery, and provide a sketch which captures the location of SMSY and SMAX for this fish population. (10 points) Answer: Differentiate the growth equation to find the maximum sustainable yield stock size, SMSY : g' (S)=γ ( 1 S S MAX) +γ S ( 1 S MAX) =γ ( 1 2 S S MAX) SMSY = ½ SMAX. The maximum growth is given by g( S MAX 2 ) MAC( =γ S 1 1/2S MAX S MAX ) =γ S MAX (Remark: 2 The growth function can also be expanded, and one gets a second degree poly-nomial that is symmetric around SMSY = ½ SMAX ). Graph on text page.

4 Course responsible: Page 4 of 5 (b) Insert an endogenously set harvest level H in the graph from part (a) such that the harvest is less than growth rate at SMSY. In your graph identify the two equilibrium stock sizes at this harvest level, and explain why one of these equilibria is unstable and the other is stable. (5 points) Answer: See the graph above, where SU is the unstable equilibrium and SS is the stable equilibrium at the harvest level H. SU is unstable because for stock sizes below SU the growth rate is less than the harvest level H, which implies that the fish population stock is driven to zero if harvest continues at H. For stock sizes between SU and SS, the growth rate is above H. Hence the stock continues to grow until the stock size SS. For stock sizes above SS, the harvest rate H is above the corresponding growth rate. This implies that the stock size will return to SS. Hence, SS is stable and SU is unstable at the harvest level H. (c) Suppose the harvest level is set at the growth rate for maximum sustainable yield. What is the stability property of this harvest level, HMSY? Under what conditions is there a risk that this harvest level is not sustainable. (5 points) Answer: First, define sustainable fishery = ability to maitain harvests over time. HMSY creates an unstable equilibrium because for stock sizes less than SMSY the growth rate of the fish population is less than the harvest level, which will lead to the stock size being reduced. This harvest is unsustainable in the sense that the fish population could be driven to extinction or severely decimated under at least two situations: (i) The stock size is wrongfully estimated, and the true stock size is less than SMSY. Then the growth rate is less than the harvest level, and the stock size will be reduced. (ii) There are yearly variations in the growth function. Suppse that for some years in row, the growth rate is less than the estimated growth associated with SMSY. This could lead to stock sizes being reduced to the extent that when there is a good growth year, the stock size is so small that the associated growth rate is still less than HMSY. Again, the fish population could be driven to extinction or severely decimated. Question 5 (20 points) Some scientists argue that there are too many reindeer in the Finnmark/Northern Troms reindeer grazing areas. Too many grazing reindeer leads to reduced slaughter weights per animal and hence lower total production of reindeer meet. The main argument in favor of this posi-

5 Course responsible: Page 5 of 5 tion is that individual reindeer herding Sámi have little incentives to reduce their flock size. On the contrary: by overstocking, each individual reindeer owner takes a larger size of the available reindeer feed (mainly lichens) at the expense of other reindeer owners. A key factor in this undesirable outcome is that reindeer owners can under-reports his or her number of reindeer on the grazing area. (a) Explain how you would frame over-stocking of grazing reindeer in a way that makes insights of the open access fishery model applicable to the reindeer problem. (10 points) Answer: The key issue here is that it is difficult to observe the number of grazing reindeer that each owner has on the grazing area. In the open access fishery model, the open access equilibrium is caused by new fishing vessels (boats) entering the fishery until rents from the fishery is zero. In the reindeer case, difficulties observing how many reindeer each owner has, means that it is difficult to limit each reindeer owner s number of grazing animals. The situation therefore resembles that of an open-access fishery: In the open access fishery equilibrium there are too many fishing boats (too much effort) which drives rents to zero, while in the reindeer case the equilibrium number of grazing reindeer leads drives slaughter weights down which lowers total meat production and hence reindeer owner rents. (b) Explain why some regulations are needed in this case. (2 points) Answer: The current situation suggests that self regulation or a cooperative solution, for example following the logic of the Folk theorem, are not met. Hence, external regulation is warranted. (c) What policy would you implement to correct for this situation? Briefly explain the reasoning behind your choice. (8 points) Answer: In the open access fishery model, the two standard solutions are (i) to tax effort, or (ii) to introduce tradable catch quotas for each fishing boat. In the reindeer edition of the open access model, the number of reindeer each owner has, is unobservable. Hence, taxing the number of grazing animals is not a viable option. The solution is therefore to regulate something that is observable, like the number of slaughtered animals. Several possibilities exist for such a regulation, but the basic principle is the same: To introduce an additional cost of delivering too many animals for slaughter. Following analogy of the permit policy of the fishery model, one could assign each reindeer owner with a maximum number of reindeer he/she can deliver for slaughter (an observable number). Making this quota transferable has two benefits: (a) It promotes a less costly solution, cfr. the conventional cost effectiveness arguments of tradable vs. non-tradable permits. (b) It introduces an additional value of for reindeer owners who reduce their number reindeer as they can sell parts of their quota, for example if a fraction of the animals scheduled for slaughter dies due to sickness, predation, or other causes. Remark: Other answers that provide incentives for reducing the number of grazing animals and promote cost effectiveness will also give full score. For example, a tax on all animals delivered for slaughter combined with a quota does the trick = compensate reindeer owners with a lump sum payment for the tax expenditures for the number of allowed reindeer.