Chapter 13 Economics of Pollution Control: An Overview Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Why Is There Pollution? • Pollution is a by-product of the production process Treated as a zero-priced input • Dispose of waste for free Otherwise have to purchase abatement equipment • Since price = 0 => consume to the point: MV = 0 However MC ≠ 0 • So have a deadweight loss due to MV < MC Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-2 Negative Externality • Marginal Private Costs < Marginal Social Costs Ideal Actual Pi Pa Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-3 Economics and Pollution Control The Two Big Questions 1. What is the optimal level of pollution? 2. How should it be allocated among its sources (firms)? Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-4 A Pollutant Taxonomy • The ability of the environment to absorb pollutants is called its absorptive capacity. • Stock pollutants are pollutants for which the environment has little or no absorptive capacity. • Fund pollutants are pollutants for which the environment has some absorptive capacity. • Local pollutants cause damage near the source of emissions while regional pollutants cause damage at greater distances. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-5 For Today • Focus on Fund pollutants • Emission rate is low enough to be absorbed by the environment No consequences for future generation • Need only address static efficiency Don’t need 2-period model (yet) Local pollutant • Effects are mostly contained within the local environment E.g., I-5 corridor (Puget Sound air basin) Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-6 What Do We Need for Efficiency? • Economic efficiency requires Minimize the costs of 1. Damages caused by pollution 2. Costs of reducing pollution At the margin (or at the optimum) • Marginal (additional) costs of reducing pollution (pollution abatement costs) = marginal damages caused by incremental change in emissions Alternatively • Maximize the benefits (derived from goods produced) • While minimizing abatement and damage costs • Yields same solution Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-7 What Do We Know About the Costs of Reducing Pollution? • Costs of reducing Additional costs of reducing pollution will be greater when level of pollution is higher Titenberg’s example • First electrostatic precipitator reduces emissions by 80% • Second (added) EP by another 80% Effectively 80% x 20% (remaining) = 16% • Third EP 80% x 4% = 3% Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-8 What Does the Cost Curve Look Like? Cost of Reducing Pollution 500 Total Costs 400 300 200 100 0 % of Emissions Reduced Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-9 How About the Costs of Damages • Similarly Marginal (additional) damage increases with an increase in the total amount of pollution Health Costs of Pollution 500 Total Costs 400 300 200 100 0 Amount of Pollution Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-10 Determining the Optimal Amount of Pollution Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-11 Optimal Level of Pollution • Occurs where Marginal damage costs = marginal abatement costs • Some simplifications that we’ve made Optimum can vary • Each firm will have different abatement costs • Not all geographic area have same damage costs More densely populated areas likely to have higher damage costs Differences in absorbing capacity of different geographic areas Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-12 How Do We Get There? • Standards (command and control) Set the overall standard at Q* Calculate the amount of reduction necessary Set uniform reduction goal for all firms • Taxes/Emission Charges Set the tax = externality cost at the optimum Q* Firms will internalize the cost • Tradable Permits (Coase) Allocate right to pollute (Q*/N) Allow firms to set price for trading permits Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-13 Cost-Effective Pollution Control Policies Emission Standards An emission standard is a legal limit on the amount of the pollutant an individual source is allowed to emit. This approach is referred to as command-andcontrol. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-14 Emissions charges An emission charge is a per-unit of pollutant fee, collected by the government. Charges are economic incentives. Each firm will independently reduce emissions until its marginal control cost equals the emission charge. This yields a cost-effective allocation A difficulty with this approach is determining how high the charge should be set in order to ensure that the resulting emission reduction is at the desired level. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-15 FIGURE 15.4 Cost-Minimizing Control of Pollution with an Emission Charge Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-16 FIGURE 15.5 Cost Savings from Technological Change: Charges versus Standards Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-17 Emissions Trading • All sources are allocated allowances to emit either on the basis of some criterion or by auctioning. The allowances are freely transferable. • The equilibrium price will be the price at which the marginal control costs are equal for both (or across all) firms. • The market equilibrium for an emission allowance system is the cost-effective allocation. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-18 FIGURE 15.6 Cost-Effectiveness and the Emission Permit System Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-19 FIGURE 15.3 Cost-Effective Allocation of a Uniformly Mixed Pollutant Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-20