environmental economics
Chapter 13

2 issues
 what is appropriate level of waste?
 how to achieve that level (who has to reduce how much?)

take usual approach
 identify efficient levels of pollution
 discuss market levels of pollution
 demonstrate how policy can reconcile

pollutant taxonomy


 stock pollutants: accumulate over time / little or no absorptive capacity
–
– nondegradable materials heavy metals fund pollutants: some capacity to be absorbed
–
– organic pollutants
CO2 efficient allocation depends on nature of pollutant

fund pollutants: efficient allocation
 if no accumulation, future damage independent of current emissions…can use static framework
 max net benefit from pollution
– minimize costs: 2 types
 damage costs (increasing in pollution)
 control / avoidance / abatement costs
(decreasing in pollution)

efficient allocation of a fund pollutant

efficiency: MCC = MDC
 points left of Q* (less pollution) inefficient
– cost > benefit in damages avoided
 points right of Q* (more pollution) inefficient
– damages > cost of cleanup
 increasing or decreasing control would increase TC

optimal pollution not zero
 cases where could be very close to zero
 MDC of first unit > first unit MCC (plutonium?)
$
MDC
MCC pollution

market allocation of pollution
 damage costs externalities; control costs not
– cheap to a firm not cheap to society
 problem particularly severe with stock pollutants
– extra burden on future generations due to accumulation

policy responses
 how to achieve MCC = MDC?
 legal limits (Q*)
 internalize damage through tax / charge system

easy in theory / difficult in practice
 need to know Q where 2 MC’s cross for every emitter (high information costs)
 alternative: select Q based on other criteria
– safe for human / ecological health
 then, how to allocate responsibility for meeting this level?
 use cost-effectiveness criterion
– not necessarily optimal, but minimizes cost given some level Q

cost-effective allocation: example
 assume 2 sources currently emitting 30 units
 reduce to 15 units
 how to allocate reduction between 2 sources?

cost-effective reductions

cost-effective reductions
 source 1 cleans up 10 units (cost A)
 source 2 cleans up 5 units (cost B)
 any other allocation…higher TC (area bigger)

demonstrates important proposition
 cost of achieving given reduction in emissions will be minimized if and only if MC of control (abatement) equal across emitters
 what policy instrument to achieve equality?
–
– emissions standards emissions charges
– emissions trading

emissions standards
 command and control
 equal reduction?
 not cost-effective
 first source lower cost
 total costs increase if both forced to clean up same

emission charges
 fee on each unit emitted
 profit-maximizing firm controls rather than emits when cheaper to do so

cost-minimizing control of pollution with an emission charge

emission charges
 if no pollution control, pay OTBC
 best can do?
 no: cheaper to pay to reduce emissions until MC reduction = emissions charge
 minimizes cost by cleaning up 10 units and emitting
5 units
 pay OAD in control, ABCD in emission charges, total costs OABC < OTBC

emission charges
 if levied same charge on both, each source would control until MC = charge, and independently choose levels of control consistent with equal MC costs
 as long as authority imposes same charges, automatically minimize TC of control
– despite lack of information on firm’s costs

how to SET appropriate emissions charge?
 iterative trial and error
 choose rate, observe reduction
– if too large, reduce
– if too small, increase
 charges not only create cost-effective allocation, also stimulates technological progress

cost savings from technological change: charges versus standards

charges vs. standards
 Q standard based on specific technology
 as new technology discovered, standards tightened
 firms have incentive to HIDE technological advances
 with charges system, firm saves $ (A+B) if can reduce pollution at MC < T
 voluntarily reduces emissions from Q0 to Q1

transferable emission permits
 can identify cost-min allocation without trial and error
 all sources required to have permits to emit
 freely transferable
 authority issues exactly # permits needed to produce desired emission level

emissions permit system

emissions permit system
 suppose source 1 has 7 permits (1 permit = 1 emission unit)
– controls 8 units
 suppose source 2 has 8 permits
– controls 7 units
 both firms have incentive to trade (MC2>MC1)

emissions permit system
 source 2 can lower cost by buying permit from source 1 at price < C
 source 1 better off selling permit at price > A
 transfer until
–
– source 1 has 5 permits (controlling 10) source 2 has 10 permits (controlling 5)
 permit price = B
– neither source had incentive to trade further

other issues with instruments
 revenue effect
–
– taxes / charge system raises revenue; permits do not may be “double dividend”…use revenue to offset other taxes

another issue: uncertainty
$
 cost of being wrong
MDC
$
MCC use charges
MDC
MCC use permits emissions controlled emissions controlled
Prevent large fluctuations in damage costs Prevent large fluctuations in control costs