Quiz 13: Trade and the Environment


Disagree. The distortion caused by pollution is the result of the difference between the private costs and the social costs of the activity that creates the pollution. Because the person choosing to take an action that creates pollution does not care about the external costs of the pollution, he tends to create too much pollution. Free trade does not alter the fact the there will remain a gap between private cost and the social cost (inclusive of the cost of pollution).

The first thing to consider is whether the mine-related pollution in the lax countries has any adverse environmental effect on the strict country. If it does not, then the strict country has no national concern about lax policies in other countries. The strict country should get its own environmental policies right. If it can import ores cheaply from lax countries, then this increases its national gains from trade. If the mine-related pollution does have an adverse effect on the strict country, then the official should be concerned, not because the lax policies are unfair, but rather because of the external cost imposed on the country. The government in the strict country should negotiate with the lax country government for appropriate regulations. If these fail, the strict country government might benefit from imposing limits on imports of ores from the lax countries, because this would lower the production and pollution created in the lax countries.

a.The shaded loss area b is now $15 million. Free trade makes the country better off, because the usual gain from trade (area a, equal to $25 million) is larger than the loss from increased pollution ($15 million). b.If there is no way to reduce pollution per ream of paper produced, then the first-best outcome can be achieved if the government imposes a tax of $0.05 per ream produced domestically. This shifts the domestic supply curve up to (S d + $0.05). The country should still export paper, but the amount that it should export is less. With the tax, the country will produce 2.15 billion reams domestically at the international price $1.10, so it will export 350 million reams.