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Claim: An emissions-fee system will always perform better than a cap and trade system when there is uncertainty about the marginal cost of pollution reduction.

1. Owing to geography and a heavy reliance on automobiles, Los Angeles (California) suffers from air pollution in the form of ’smog’. The Los Angeles Basin is susceptible to atmospheric inversion, which holds in the exhausts from road vehicles, airplanes, locomotives, shipping, manufacturing, and other sources. It is estimated that each “mile driven” M imposes damage in the form of smog of $100 on society. The Marginal benefit of driving for a single person (in a given year) is given by

?MB = 500 ? M

The private marginal cost of driving is 0.

. (a) Illustrate the market for “miles driven,” in Los Angeles, indicating whether in this market there is a producer or consumer externality, and whether it is positive or negative.

. (b) What is the amount of Deadweight loss per person?

. (c) Justify government intervention in this market, on the basis of your graph.

. (d) If the City wanted to correct this externality using fees/taxes, what kind of program should it set up?

2. Suppose there are three types of families in a community. They all have the same utility over education and other goods, which both have price $1:

?U(G,E) = 1/4lng +3/4lnE

but differ in their income; Some households have 100 dollars, some have 200 dollars, some have 500 dollars.

. (a) Find the amount of education each household would choose in a private market for education.

. (b) Suppose this community decides to make available 100 units of education, for free. Which households will send their child to public school? Is there any crowding out?

(c) Suppose instead they community makes available a $100 dollar voucher, than can be used either at the public school (if E = 100 is chosen), or at a private school. How much education will each family choose under this policy? Is there any crowding out? What will happen to the public school?

(d) Which policy costs the community more?

3. The city of Greenspace, WA, is deciding how much to spend on public parks. There are three types of household, (A,B,C) with different preferences over the amount of spending, P . There are 50 of each type of households. There are three levels of P, H, M and L, for high, medium and low. Preferences are

A Households :H? M? L

B Households :M? L? H

C Households :L? H? M

(b) Suppose a C household is chosen as the “agenda-setter,” and will choose the order of the pairwise votes, with the winner in the first vote going on to the second. Can this household use this power to improve the outcome (from their point of view)? Explain why or why not.

(c) Suppose that the make up of this community changes, so that there are now 100 households of type A, 25 of type B, and 25 of type C. What power does a type C agenda setter have now?