Title: Problem Set 7

Page 1

Please complete the table below:

Question 1

- [Image: air]
- [Image: harmful]
- [Image: permits]
- [Image: R&D]
- [Image: manufacturers]
- [Image: insufficient]
- [Image: subsidies]
- [Image: insufficient rental]
- [Image: principal agent]
Q: air pollution
A: [Image: air]
Q: health
A: [Image: harmful]
Q: permits
A: [Image: permits]
Q: rd spillovers
A: [Image: R&D]
Q: manufacturers
A: [Image: manufacturers]
Q: insufficient investments
A: [Image: insufficient]
Q: principal agent
A: [Image: principal agent]
Q: rental properts
A: [Image: insufficient rental]
Q: subsidies, labelling, regulation
A: [Image: subsidies]

There are market failures in the form of behavioural anomalies related to the energy sector that are addressed by appropriate policy instruments. Please complete the following table:

Question 2

- [Image: Insufficient investments + imperfect decisions]
- [Image: Insufficient investments]
Q: 1
A: [Image: Insufficient investments + imperfect decisions]
Q: 2
A: [Image: Insufficient investments]

Page 2

Assign the energy and climate policy instruments:

Question 3

- Feed-in-tariffs

Information campaigns

Emission standards

Environmental taxes

Technology standards

Targeted subsidies
- Market-oriented instruments
- Non-market-oriented instruments
Q: market-oriented
A: Market-oriented instruments
Q: non-market-oriented
A: Non-market-oriented instruments
Q: market-oriented
A: Market-oriented instruments
Q: non-market-oriented
A: Non-market-oriented instruments
Q: market-oriented
A: Market-oriented instruments
Q: market-oriented
A: Market-oriented instruments

Question 4

Q: What are the main goals of energy policy?
- Security of supply (correct)
- Only domestic energy production
- Ecological supply (correct)
- Economical and affordable supply (correct)
- Only renewable energy production (correct)

There are different types of taxes that can be used to internalize the negative externalities due to energy use that arise from environmental damage or climate change. Please attribute the following statements to the right market-based instruments.

Question 5

- It taxes the polluting inputs (e.g. fossil fuels, coal) and indirectly the emission.

It directly taxes the pollution.

It taxes the output of polluting firms.

The tax is set equal to the marginal external cost of pollution.
- Pollution tax
- Energy tax
- Product tax
Q: energy tax
A: Energy tax
Q: product tax
A: Product tax
Q: pollution tax
A: Pollution tax
Q: pollution tax
A: Pollution tax

In the context of an international agreement on climate change, please indicate if the following statements are true or false:

Question 6.1

Q: Generally, international treaties contain only binding agreements.
A: false

Question 6.2

Q: A binding contract represents a legally enforceable voluntary commitment by states to take specific actions.
A: true

Question 6.3

Q: A non-binding agreement does not entail legal obligations.
A: true

Question 6.4

Q: It is hard to negotiate this type of strong binding agreement.
A: true

Page 3

Assign the areas in the graph (described by capital letters) to the descriptions below the graph.

Question 7

- B + E + F
- A + B + C + D
- C
- C + D + E
- D + E
- B + C + D + E
- C + D
Q: D + E
A: D + E
Q: A + B + C + D
A: A + B + C + D
Q: C + D + E
A: C + D + E
Q: C
A: C

Page 4

The graph shows the marginal social benefits (MSB) the marginal private costs (MPC) and the marginal social costs (MSC) for an electricity market. The government introduces a tax on electricity that reflects the MSC. Label the graph below.

Question 8

- MPB
- MSC
- a
- MPC
- b
- a + b
- Quantity with tax
- Quantity without tax
Q: b
A: b
Q: MSC
A: MSC
Q: MPC
A: MPC
Q: Quantity with tax
A: Quantity with tax
Q: Quantity without tax
A: Quantity without tax
Q: a
A: a
Q: a + b
A: a + b
Q: MPB
A: MPB

Question 9

Q: Consider a competitive market where the supplier of oil faces marginal private costs of \(MPC=100+10Q_s\). Moreover the marginal external costs of \(MEC=6Q\) are not taken into account by the supplier and the consumers. Marginal private and social benefits from the consumption of oil is equal to \(MPB=MSB=1000−20Q_d\).

Please calculate the difference between the equilibrium quantity in the market (without considering the MEC) and the socially optimal quantity (considering the MEC).
- The equilibrium quantity not considering the MEC is 10 units smaller compared to the equilibrium quantity considering the MEC.
- The equilibrium quantity not considering the MEC is 10 units larger compared to the equilibrium quantity considering the MEC.
- The equilibrium quantity not considering the MEC is 5 units smaller compared to the equilibrium quantity considering the MEC.
- The equilibrium quantity not considering the MEC is 5 units larger compared to the equilibrium quantity considering the MEC. (correct)

Page 5

Feed-in-Tariffs (FiTs) are a type of subsidy used to promote the adoption of renewable energy. There are three main types of FiTs, that are illustrated below, please, drag the correct type of FiTs to its corresponding graph.

Question 10

- Fixed-price FiT
- Non-variable premium price FiT
- Variable premium price FiT
Q: fixed
A: Fixed-price FiT
Q: non-variable
A: Non-variable premium price FiT
Q: variable
A: Variable premium price FiT

Question 11

Q: The producer will receive always the same price for her produced electricity with which of the following feed-in-tariff schemes?
- Fixed price feed-in-tariff model (correct)
- Feed-in-tariff following the spot-market gap model
- Non-variable premium-price feed-in-tariff model

Page 6

Question 12

Five coal power plants have the same marginal abatement cost curves and are polluting the same quantity of emissions. The overall reduction in emission imposed by the government is 75 tones of CO2. What is the optimal level of abatement per firm in tones?

Q: [...]
A: 15

Two firms in the energy sector have two distinct marginal abatement cost curves MAC1 and MAC2 showed below. Please indicate if the following statements are true or false.

Question 13.1

Q: Firm 1 experiences bigger increases in abatement costs than firm 2, for each additional unit of abatement.
A: false

Question 13.2

Q: The most efficient way to distribute the abatement costs between the two firms is the introduction of a tax set at the level t, where MAC1 and MAC2 intersect.
A: true

Question 13.3

Q: At tax rate t, the total abatement cost of firm 1 is given by area B.
A: true

Question 13.4

Q: Firm 1 pays more than firm 2 for the tax revenue.
A: false
If right: False because A+B > C+B
If wrong: False because A+B > C+B

Question 13.5

Q: The total tax revenue in this simplified economy is A+B+C+D.
A: true

Question 13.6

Q: The total abatement costs in this simplified economy are E+F.
A: false
If right: The total abatement costs are given by B+C
If wrong: The total abatement costs are given by B+C

Page 7

The graph below depicts two individual firms with two distinct Marginal Abatement Costs (MAC). Imagine that they both receive the same quantities in permits to abate the overall quantity a-b.

Please, indicate if the following statements are true or false:

Question 14.1

Q: Firm 1 could consider selling some of its permits to Firm 2.
A: true

Question 14.2

Q: Trading would not benefit both firms.
A: false

Question 14.3

Q: Firm 2 will abate a lower amount of CO_2 emissions than Firm 1 if trading is allowed.
A: true
If right: Yes because b*-a > b*-b
If wrong: Yes because b*-a > b*-b

Question 14.4

Q: The marginal abatement costs of Firm 2 are always higher than those of Firm 1.
A: false

Page 8

Question 15

Q: In 1996, Michigan launched a voluntary emissions trading program, which allows polluters to achieve cost-effective solutions meeting requirements of the U.S. Clean Air Act. Suppose that Michigan’s objective for two major coal power plants in an urban area is a 16% reduction in carbon monoxide (CO) emissions and that each firm faces the following costs:

Power plant 1 has total abatement costs of \(TAC=1000+2.5A_1^2\) and thus marginal abatement costs of \(MAC=5A_1\).

Power plant 2 has total abatement costs of \(TAC=2000+1.5A_2^2\) and thus marginal abatement costs of \(MAC=3A_2\) where \(A_i\) represents in each case the percentages of CO emission abatement achieved by coal power plant 1 and 2, respectively.

Calculate the TAC for each power plant if a uniform abatement standard is used. (Hint: Overall abatement satisfies: \(A_1+A_2=16\).
- Total abatement costs are 1160 for plant 1 and 2096 for plant 2. (correct)
- Total abatement costs are 1160 for plant 1 and 1900 for plant 2.
- Total abatement costs are 1200 for plant 1 and 2096 for plant 2.
- Total abatement costs are 1200 for plant 1 and 1600 for plant 2.

Question 16

Q: Is there an economic incentive for the two power plants to participate in the trading program?
- With a uniform abatement standard, the MACs are unequal and each firm could realize cost savings by changing this allocation through participation in the trading program. (correct)
- In order to be in the most cost-efficient situation, plant 1 should abate less, and plant 2 should abate more. (correct)
- With a uniform abatement standard, the MACs are unequal and only plant 2 could benefit by changing this allocation through participation in the trading program.
- In order to be in the most cost-efficient situation, the plants should continue to abate the same amount.
- With a uniform abatement standard, the MACs are unequal and only plant 1 could benefit by changing this allocation through participation in the trading program.
- In order to be in the most cost-efficient situation, plant 2 should abate less, and plant 1 should abate more.
- With a uniform abatement standard, the MACs are unequal and each firm could not realize cost savings by changing this allocation through participation in the trading program.

Question 17

Quantify the cost savings associated with a cost-effective abatement allocation that could be achieved through trading. What is the absolute value of cost savings?

Q: [...]
A: 16

Question 18

At what price must each tradable permit be set to achieve the cost-effective solution?

Q: [...]
A: 30

Page 9

The following graph shows the choice of the level of energy efficiency of heating systems. The graph includes three demand functions: the marginal private benefits function demand of a rational consumer (MPB_R) the perceived marginal benefits function of a bounded rational consumer (MPB_BR) and the marginal social benefits function (MSB) for energy efficiency of heating systems from a societal point of view. The graph also includes the upward-sloping marginal energy reduction cost curve (MERC), which indicates the increasing marginal costs of improving the heating system’s energy efficiency and of reducing energy consumption.

Please, drag the items to the right places.

Question 19

- MERC
- MPB_R
- MPB_BR
- MSB
- Subsidy
- EE_BR
- EE_R
- EE*
- P_R
- P*
- P_BR
Q: P*
A: P*
Q: P_BR
A: P_BR
Q: P_R
A: P_R
Q: MERC
A: MERC
Q: Subsidy
A: Subsidy
Q: EE_BR
A: EE_BR
Q: MPB_BR
A: MPB_BR
Q: EE*
A: EE*
Q: MPB_R
A: MPB_R
Q: EE_R*
A: EE_R
Q: MSB
A: MSB

Page 10

Question 20

Q: Which of the following policy instrument(s) is /are a nudge?
- Energy labels on appliances (e.g. dishwasher) (correct)
- Default option when selecting a contract (e.g. electricity at home) (correct)
- Prohibition of a certain type of heating system in a house
- Legal maximum to energy usage for an appliances (e.g. dishwasher)

Question 21

Q: Which of the following statements describes a nudge best?
- Laws / rules that prescribe what people can do or choose. These laws / rules are in their broad self-interest and, at the same time, are in the interest of society
- Suggestions / invitations that encourage people to make decisions that are in their broad self-interest and, at the same time, are in the interest of society. (correct)