Refer to the Figure above. MAC₁ represents a mis-estimation of abatement costs. True abatement costs are MAC₂; however, the regulatory agency believes that the costs are represented at MAC₁ and sets policy accordingly. Due to this error, emissions are ________ than the socially efficient level and damages are ___________ than the socially efficient level. A) lower; lower B) lower; higher C) higher; lower D) higher; higher

Question

Quizplus · Accepted Answer

If the regulatory agency underestimates the true abatement costs, it is likely to set stricter environmental regulations than would be socially optimal, believing that it is cheaper for firms to reduce emissions than it actually is. This leads to lower emissions than the socially efficient level, but because the policy is based on incorrect cost estimations, the overall damages (including the excessive costs of abatement) are higher than they would be at the socially efficient level of emissions.

Refer to the Figure Above