Australian carbon scheme

1. Australian carbon scheme
This question asks you to analyze the e ffects of the introduction of a carbon scheme that was
recently approved by the Australian parliament. In the first phase of the scheme, a tax on carbon of
AU$25 per ton of carbon emitted is imposed on the 500 largest polluting firms emitting 500
million tons of carbon per year (before the tax is introduced). In the second phase of the scheme, a
cap and trade system is introduced instead of the carbon tax.
(a) The Australian government predicts that the carbon tax will reduce the quantity of emission by
100 million tons per year. How much will be the government revenue for this tax?
(b) In order to minimize the negative impact of this tax on the Australian firms, the government
has designed some compensation packages. Assume that the government uses all the revenue from
the carbon tax to compensate the 500 firms. Explain why the 500 firms are still worse o ff.
(c) Does the carbon tax that the Australian parliament approved, generate a deadweight loss?
Explain.
(d) Now consider the following three firms. After the introduction of the tax, firm 1 reduces
emissions of carbon by 2 million tons (that is, it abates 2 million tons or A ∗ 1 = 2); firm 2 reduces
emissions of carbon by 500,000 tons (that is, it abates 500,000 tons or A ∗ 2 = 0.5); firm 3 does
not reduce emissions at all (that is it abates zero or A∗ 3 = 0).
i. What is the marginal cost of abatement of firm 1 of abating 2 million tons that is MC1 (A ∗ 1)?
Explain.
ii. What is the marginal cost of abatement of firm 2 of abating 500,000 tons that is MC2 (A ∗ 2)?
Explain.
iii. What is the marginal cost of abatement of firm 3 of abating zero tons that is MC3 (A ∗ 3)?
Explain.
(e) Now assume that the prediction of the government is correct and that after the introduction of
the carbon tax, the emissions of carbon de- crease to 400 million tons per year. In the second phase
of the carbon scheme, the carbon tax is eliminated and the government allocates 400 million
carbon permits which allow emissions of 400 million tons of carbon to the firms. Those permits
can be bought and sold in a national market (cap and trade). If nothing else changes between the
first and the second phase of the carbon scheme, what is the price that you expect to observe in the
market for carbon? Explain.
(f) Keep assuming that the government allocates 400 million carbon permits. Can you determine
the quantity of emissions each firm in part d) will abate? Explain.