Suppose that an environmental protection agency (EPA) is concerned with the nutrient pollution in a lake mainly due to a nearby firm, which creates pollution, denoted by M, as by-product in the facility. EPA has investigated the situation by estimating the marginal damage (MD), which is a flat curve (with respect to the pollution level), and the firm's marginal abatement cost (MAC), which would decrease linearly with the pollution level. Answer the following questions and explain your reasoning. (a) [8 marks] Illustrate MD and MAC on a graph and indicate the equilibrium pollution level and hypothetical (shadow) price. Shade the areas that represent the environmental damage and the cost of abatement clearly. (b) [8 marks] Under which conditions (for MD and MAC) can pollution can be avoided completely? Explain your intuition for your answer. (c) [8 marks] Suppose that the EPA has underestimated the firm's MAC (i.e. the MAC is actually higher). Discuss its implications on the equilibrium pollution level. Which instrument (quantity- or price- based control system) would yield a lower welfare loss in this case, and so is more desirable? (d) [6 marks] Suppose, instead, that the EPA has overestimated the MD (i.e. the MD is actually lower). Discuss its implications on the equilibrium pollution level. Which instrument (quantity- or price- based control system) would yield a lower welfare loss in this case, and so is more desirable? Suppose that an environmental protection agency (EPA) is concerned with the nutrient pollution in a lake mainly due to a nearby firm, which creates pollution, denoted by M, as by-product in the facility. EPA has investigated the situation by estimating the marginal damage (MD), which is a flat curve (with respect to the pollution level), and the firm's marginal abatement cost (MAC), which would decrease linearly with the pollution level. Answer the following questions and explain your reasoning. (a) [8 marks] Illustrate MD and MAC on a graph and indicate the equilibrium pollution level and hypothetical (shadow) price. Shade the areas that represent the environmental damage and the cost of abatement clearly. (b) [8 marks] Under which conditions (for MD and MAC) can pollution can be avoided completely? Explain your intuition for your answer. (c) [8 marks] Suppose that the EPA has underestimated the firm's MAC (i.e. the MAC is actually higher). Discuss its implications on the equilibrium pollution level. Which instrument (quantity- or price- based control system) would yield a lower welfare loss in this case, and so is more desirable? (d) [6 marks] Suppose, instead, that the EPA has overestimated the MD (i.e. the MD is actually lower). Discuss its implications on the equilibrium pollution level. Which instrument (quantity- or price- based control system) would yield a lower welfare loss in this case, and so is more desirable
