Chapter 13
Economics of
Pollution Control: An
Overview
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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
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Negative Externality
• Marginal Private Costs < Marginal Social Costs
Ideal
Actual
Pi
Pa
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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)?
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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
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Determining the Optimal
Amount of Pollution
Tax
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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
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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
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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.
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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.
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FIGURE 15.4 Cost-Minimizing Control
of Pollution with an Emission Charge
Tax = mc of control
Tax
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FIGURE 15.5 Cost Savings from
Technological Change: Charges versus
Standards
Both firms reduce to the same level
But have different mcosts
Using tax
Get less emissions
standard
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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.
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FIGURE 15.6 Cost-Effectiveness and
the Emission Permit System
Standard
MC of emitting 8
Bid range
Tax
MC of emitting 7
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Tradable Permits
A Property Rights Approach
• “Common” Property Problem

No one “owns” the air/water; therefore no one
benefits from managing (pricing) its usage
• Solution is to assign the property right to one
party and allow them to trade its use in the
marketplace

Coase Theorem
Coase’s Theorem
• If property rights exist and transaction
(bargaining) and information costs are low

Then parties will be able to bargain among
themselves (without government intervention) to
obtain an efficient outcome
Assigning the Property Rights
• If assigned to the firm

Farmer is willing to “bribe” the firm to reduce
pollution
• Willing to pay firm to reduce gallons discharged up
to marginal value of crop damage due to pollution
• Firm: willing to accept payments that are >= marg
costs of treatment/reduction
Assigning Property Rights
• Assigned to the Farmer

Firm is willing to pay farmer up to the marginal
value of “avoided” treatment costs

Farmer is willing to accept payments >= marginal
cost of crop damage
• Either way: socially efficient (marginal value
= marginal cost) solution

However, there are different income effect
• Concluding which is best => normative statement
FIGURE 15.3 Cost-Effective Allocation
of a Uniformly Mixed Pollutant
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Comparison of Approaches
• Standards



Can also produce optimal level of pollution
• But set same standard for all firms (and are not
productively efficient, e.g. min cost)
• To set individual quotas: requires knowledge of each
firm’s costs
But have higher administrative costs
• Not only have to monitor emissions
• Enforcement costs: legal proceedings (time delays and
expense)
• Not very flexible: regulatory process for changing
standards
Provide no incentive for firms to reduce pollution below
current “authorized” levels
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Comparison of Approaches
• Standards

Are most useful when:
• Problem is short-lived (“burn” bans for high
pollution days)
• Optimal level is zero – pollutant is highly toxic
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Comparison of Approaches
• Taxes

Can produce “optimal” amount of pollution at minimum costs
and lower administrative costs
• Kneese (1977): comparing taxes versus standards
found that desired quality costs half as much using taxes

Automatically allocates pollution levels among firms based
on their costs
• Provides incentive for firms to reduce pollution levels
through technological innovation

Easy to adjust/”tune”

Tax revenues can be used finance admin costs
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Comparison of Approaches
• Tradable Permits


Cost efficient
• Firms will purchase permits from more efficient firms if
permit cost < abatement (technology) costs
Technological incentive to reduce pollution
• Marginal cost of abatement = permit cost


Administratively simpler
• Require less information about the firms’ cost
• Better able to handle “spatial” variation in pollution


Similar to taxes
Fewer permits auctioned in bad areas
• Adjust “automatically” for changes in inflation and growth
If auctioned -> revenues for admin costs or for “buyback”
programs
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