Consider the problem of carbon dioxide emissions. We will abstract from the complexity of the problem slightly, assuming there are polluters and consumers in two regions, the OECD (O) and the rest of the world (R). Suppose the marginal cost of controlling CO2 emissions is $13 per ton. Let the marginal willingness to pay for pollution reduction be 14 – Q for region O and 8 – 2Q for region R, where Q is the amount of pollution reduction.
The United Nations is considering two proposed methods for controlling CO2 emissions, both involving polluters paying for the damage they cause:
Proposal A involves the polluters paying damages to each region for the pollution generated.
Proposal B involves the polluters in each region independently negotiating pollution reductions with the consumers of their respective region, assuming the other region is not undertaking pollution reduction.
What is the socially efficient level of emissions reduction Q*? A graph of the marginal abatement cost and the total marginal willingness-to-pay curves would be helpful. (Hint: CO2 emission reduction is a global public good)
How much total pollution reduction will occur under Proposal A and what will be the total compensation received by regions O and R? If those payments were instead placed in the general coffers of the UN, would the outcome be any different from an efficient point of view? Why or why not?
How much pollution would be generated under Proposal B? Explain any differences between this answer and the answer to parts (a) and (b).