Homework I

Houston Clean Air

Spring, 2007 Prof. S. Craig

Directions: Draw two graphs, to illustrate #1 and #2. Describe each graph in not more than three sentences. Then write one paragraph (not more than 150 words) which answers the question about which is the better proposal. Turn in your work, typed, by Tuesday, Feb 6, at 11:30 am.

George Bush has declared that gasoline consumption needs to be reduced to improve the environment (among other reasons). The federal EPA has decreed that Houston currently has an air pollution problem (although it is mainly that LA has reduced its pollution so much, while ours has been about constant). Assume that there are two policy proposals for Houston to meet the Clean Air Act allowable pollution levels. Proposal one is a gasoline tax of $.50 per gallon (about 20% of the price). The other proposal is to require a pollution test each year (as we do currently), and then charge each car an amount based on the level of pollution from the car times the number of miles the car has been driven the past year. This proposal is expected to cost each driver slightly less than the gas tax on average.

#1 First, show the lost gains from trade to the local economy resulting from people driving without accounting for the pollution costs they impose on others (it is probably most useful to show the gasoline market, though an alternative is to show the demand for transportation).

Advocates of the gasoline tax argue that it will encourage people to drive less, and to drive more fuel efficient cars. Show graphically the effect of the tax on the gasoline market, and show whether the market result is closer to the socially optimal level of output. Make your elasticity assumptions explicit.

#2 The second policy proposal is to charge each vehicle according to its level of pollution. Graphically show whether this policy will increase or decrease social efficiency.

Now discuss the reality of these policy proposals, and discuss which is the “better” proposal. Be explicit about your criteria for selecting a proposal. In your answer, discuss whether the gasoline tax will affect all drivers (pollution producers) equally. In what sense will the unequal distribution be efficiency enhancing, or efficiency distorting? Why? Feel free to enumerate what additional information you would need to properly answer these questions, but also feel free to assume the answers and reach a conclusion (even if, like all thinking persons, you withhold the right to change your mind as more or new information becomes available!).