670 PART • Information, Market Failure, and the Role of Government Dollars per unit of emissions MCA MCA F IGURE 18.6 THE CASE FOR FEES With limited information, a policymaker may be faced with the choice of either a single emissions fee or a single emissions standard for all firms The fee of $3 achieves a total emissions level of 14 units more cheaply than a 7-unit-per-firm emissions standard With the fee, the firm with a lower abatement cost curve (Firm 2) reduces emissions more than the firm with a higher cost curve (Firm 1) 3.75 2.50 Firm 1’s Increased Abatement Costs Firm 2’s Reduced Abatement Costs 1 10 11 12 13 14 Level of emissions cost-minimizing because the second firm can reduce emissions more cheaply than the first Only when the marginal cost of abatement is equal for both firms will emissions be reduced by 14 units at minimum cost Now we can see why a fee ($3) might be preferable to a standard (7 units) Faced with a $3 fee, Firm will reduce emissions by units and Firm by units—the efficient outcome By contrast, under an emissions standard, Firm incurs additional abatement costs given by the green-shaded area between and units of emissions But Firm enjoys reduced abatement costs given by the purple-shaded area between and units Clearly, Firm 1’s added abatement costs are larger than Firm 2’s reduced costs The emissions fee thus achieves the same level of emissions at a lower cost than the equal per-firm emissions standard In general, fees can be preferable to standards for several reasons First, when standards must be applied equally to all firms, fees achieve the same emissions reduction at a lower cost Second, fees give a firm a strong incentive to install new equipment that would allow it to reduce emissions even further Suppose the standard requires that each firm reduce its emission by units, from 14 to Firm is considering installing new emissions devices that would lower its marginal cost of abatement from MCA1 to MCA2 If the equipment is relatively inexpensive, the firm will install it because it will lower the cost of meeting the standard However, a $3 emissions fee would provide a greater incentive for the firm to reduce emissions With the fee, not only will the firm’s cost of abatement be lower on the first units of reduction, but it will also be cheaper to reduce emissions by more units: The emissions fee is greater than the marginal abatement cost for emissions levels between and THE CASE FOR STANDARDS Now let’s examine the case for standards by looking at Figure 18.7 While the marginal external cost curve is very steep, the marginal cost of abatement is relatively flat The efficient emissions fee is $8 But suppose that because of limited information, a lower fee of $7 is charged (this fee amounts to a 1/8 or 12.5 percent reduction) Because the MCA curve is flat, the firm’s emissions will be increased from to 11 units This increase lowers the