Please attempt the following. I will go over Question 5 next lecture.
1a) Please give two reasons why a Pigouvian tax is generally preferable to a Pigouvian subsidy. (4 points)
1b) If markets fail, is government intervention always justified? Please set out your reasoning. [Two sentences.] (4 points)
2) By drawing an appropriate diagram, please explain how the government would set a Pigouvian tax with reference to that diagram. (Your diagram should show the relevant marginal cost and benefit schedules associated with producing a given level of output Q.) Please label the diagram appropriately, and in giving your answer, make sure that you state the rule for setting the Pigouvian tax in an optimal way. (7 points)
Question 3 (worth 7 points)
Suppose there are two types of firm in an industry – type I and type II firms - and production by these firms gives rise to pollution emissions. Both types of firms have linear marginal benefit of emissions schedules that intersect the horizontal axis at the same point (e0), but type I firms have steeper benefit schedules.
3a) In the space below, draw a diagram representing the marginal benefits to each type of firm from higher emissions, with emissions (e) on the horizontal axis. (Assume that the marginal private cost of emissions is zero for both types of firm, in the absence of government intervention.) (1 point)
3b) In the absence of any regulation, what level of emissions will each type of firm choose to produce and why? Answer with reference to the diagram. (2 points)
3c) Suppose the government knows the MSC of emissions, and that this is a horizontal line. What emissions standard (or quantity of emissions) would it set for each type of firm, and could the same standard for both types of firm be efficient? (4 points)
Question 4 (worth 6 points)
In a particular community in Mississauga, officials are considering a scheme to improve local air quality by 10 percent. They have hired some economists to estimate the willingness of households to pay for air quality improvements, and these economists obtain reliable estimates indicating that, on average, households would pay 1.4 percent of their house value for a 10 percent improvement in air quality. Suppose that the average house price is $100,000, and that there are 100 families in the community. Suppose also that the improvement would cost $160,000 to implement, and ignore any possible benefits to the inhabitants of other communities. Should the improvement go ahead? Please set out your working clearly. (6 points)
Question 5 (worth 14 points)
You have been asked to carry out an econometric exercise, measuring the dollar value of clean air using data on house prices in Ontario. Your data set consists of a random sample of houses in the province. Specifically, for each house, you have information on house’s price, house size, whether the house in a city or rural area, and an index measuring local air quality. (For this index, a higher value implies worse air quality.)
5a) Using the available data set, how would you go about measuring the value of clean air? Say what regression you would run, precisely. (3 points)
It is clear that the data set provides very little information about the true quality of a local neighborhood – to you, neighborhood quality is effectively unobserved. However, suppose that housing developers are able to observe the attributes of a neighborhood that make it a desirable place to live. And suppose that, as the neighborhood becomes more desirable, so developers would like to build larger houses.
5b) What will this type of behaviour tend to mean for any coefficient you estimate on house size? Will it be biased up or down? Please explain. [4 sentences] (7 points)
5c) What is this source of bias an instance of? (2 points)
5d) Can you suggest additional information that you might want to add to the data set that would help provide accurate house value estimates? Please be specific. [One sentence] (2 points)