Chapter 6
Air Pollution: Balancing Benefits and Costs
What's in This Chapter and Why
This chapter emphasizes the economic aspects of air pollution. It provides a brief overview of the
principal air pollution problems and an analysis of how these problems arise naturally in a market
economy.
The principal tools for correcting these problems are authorized by the Clean Air Act. Users
will find an extensive discussion of the features of this act. How it works is explained, and then its
effectiveness in reducing air pollution is evaluated. The benefits and costs of air quality
regulations are also examined. The chapter closes with an examination of the two means favored
by economists for reducing the costs of environmental regulation: emissions taxes, and marketable
pollution permits.
Instructional Objectives
After completing this chapter, your students should know:
1.
2.
3.
4.
5.
6.
7.
8.
The causes and consequences of the principal air pollution problems.
The difference between waste and pollution.
The rules for determining the efficient levels of production, pollution, and pollution control.
Why a competitive market tends to produce too much pollution and create a net social loss.
The principal features of the Clean Air Act.
The accomplishments of air quality regulation in the United States.
The costs and benefits attributable to air quality regulation.
How the costs of environmental regulation can be reduced by using emissions taxes and
marketable pollution permits.
Key Terms
These terms are introduced in this chapter.
Acid rain
Greenhouse gas
External costs
Marginal external costs (MEC)
Marginal social costs (MSC)
Efficiency loss from pollution
Property right
Common property resource
Coase’s Theorem
Ambient concentrations
Emissions reduction credit
Criteria pollutants
Emissions tax
Marginal abatement cost
Marketable pollution permit
Transaction costs
Suggestions for Teaching
Today's students appear to be concerned about the environment, so you should have little difficulty
generating interest in this topic. Many students will come to class, however, with the view that all
pollution should be eliminated. One of your primary tasks will be to get them to see that there are
78
Instructor's Manual  79
both benefits and costs associated with pollution control--that there are trade-offs involved in
achieving a cleaner environment.
The chapter begins with a description of the principal air pollution problems and stresses their
biological and physical effects. It is important for students to have some knowledge of the nature
of air pollution before they analyze its economic causes and consequences.
Aim to convince your students that there is an efficient level of pollution, and that this level is
not likely to be zero pollution. They will understand this when they become well-versed in the use
of marginal analysis applied to pollution problems. The chapter contains several examples of this
type of analysis. Students should work them out carefully.
A key feature of the chapter is the portrayal of pollution as a source of market failure, even in a
competitive economy. Such a failure produces net social losses and a prima facie rationale for
government involvement. Students should be reminded that this is the standard approach in
normative economics.
The existence of market failure is a necessary, but not a sufficient condition, for government
action. To deal with this point more precisely, we raise the possibility that only minimal
government action in the form of property rights assignment and enforcement is required, as
outlined by Ronald Coase. It is generally found that the conditions under which this arrangement
will solve the problem of pollution is too restrictive. The regulations spawned by the federal Clean
Air Act (CAA) is then examined, and it is discovered that environmental regulation can produce
costs in excess of benefits and excessive costs for benefits achieved. What is painted, then, is a
picture of both market and government failure.
The possibility of revising the government's approach to the pollution problem in a manner that
will ever achieve the efficient level of pollution (where marginal cost of regulation equals marginal
benefit of regulation) is questionable. The prospects for reducing the costs of regulation through the
expanded use of emissions taxes and marketable pollution permits are, however, good.
Additional References
In addition to the references in the text, instructors may wish to read or assign one or more of the
following:
1. Arnold, Frank S., "Environmental Protection: Is It Bad for the Economy?" Office of Economy
and Environment, U.S. Environmental Protection Agency, July 9, 1999.
2. Brown, Stephen P. A. "Global Warming Policy: Some Economic Implications," Economic
Review, Federal Reserve Bank of Dallas, 4th quarter, 1998, 26-35.
3. Burtraw, Dallas, et al, "The Costs and Benefits of Reducing Acid Rain," Resources for the
Future Discussion Paper 97-31-REV, September, 1997.
4. Council on Environmental Quality. Annual Report. Washington, D.C.: Government Printing
Office.
5. Oats, Wallace E. "Markets for Pollution Control," Challenge (May-June 1984), pp. 11-17.
6. Portney, Paul, ed. Public Policies for Environmental Protection. Washington, D.C.: Resources
for the Future, 1990.
7. Tietenberg, Tom, Environmental and Natural Resource Economics, 3rd ed. (New York, N.Y.:
Harper Collins, 1992), pp. 369-376 and 406-412.
80  Chapter 6/Air Pollution: Balancing Benefits and Costs
Outline
I. THE PRINCIPAL AIR POLLUTION PROBLEMS
A. Urban Air Quality
1. The quality of urban air is measured in terms of six common air pollutants: total
suspended particulates, sulfur dioxide, carbon monoxide, nitrogen dioxide, ozone, and
lead.
2. Concern about urban air quality stems from the adverse effects that pollution has on
human health, crops and plants, property, safety, and visibility.
B. Acid Rain
1. Acid rain has its chemical origin in compounds formed principally from sulfur dioxide
emitted from electrical generating plants. These compounds fall to the earth as a part
of natural precipitation, often far from the place of origin.
2. Acid rain affects the ability of lakes and streams to sustain aquatic life, the growth and
mortality rate of forests, and human health.
C. Global Warming
1. Global warming refers to the increased warming of the planet caused by an increase in
the emission of greenhouse gases, particularly carbon dioxide.
2. Global warming could threaten lives and coastal properties by causing an increase in
ocean levels and could affect the location of the world's croplands and forests by
altering weather patterns.
D. Stratospheric Ozone Depletion
1. Ozone (when present in the stratosphere) is a gas that protects the earth from harmful
solar ultraviolet radiation.
2. Emissions such as chlorofluorocarbons enter the stratosphere and destroy ozone while
other emissions such as carbon dioxide and methane increase the atmospheric
concentration of ozone.
3. The net effect of these emissions is not known with certainty; however, there are
indications that significant decreases in ozone have occurred in some parts of the
world, and that further decreases could occur if the use of chlorofluorocarbons is not
reduced.
E. Hazardous Air Pollutants
1. There are hundreds, perhaps thousands, of toxic substances that may be transported by
the air.
2. These pollutants have been linked to central nervous system damage and cancer in
humans.
II. THE ECONOMIC PERSPECTIVE
A. Marginal Cost
1. Marginal cost (MC) is the cost of producing an additional unit of a commodity that is
paid by those producing the commodity. The marginal cost curve is the firm's supply
curve.
2. Marginal external (MEC) cost is the cost of producing an additional unit of a
commodity that is not paid by those producing or consuming the commodity. Pollution
costs is an example of MEC.
Instructor's Manual  81
3. Marginal social cost (MSC) is the cost of producing an additional unit of a commodity
that is paid by society. Marginal social cost includes both marginal external and
marginal cost.
B. Marginal Benefit
1. The demand curve represents marginal benefit. The vertical distance at each quantity
shows the amount consumers are willing to pay for that unit. Willingness to pay
reflects the benefit derived from each unit.
C. Competitive Markets and Efficiency
1. A competitive market will produce at the point where quantity demanded and quantity
supplied are equal, or where marginal benefit equals marginal cost.
a. If external costs exist, a competitive market will produce an inefficient amount of
the good. At the point where quantity demanded and quantity supplied are equal,
marginal social cost exceeds marginal benefit and too much of the good is
produced. Since marginal social cost exceeds marginal benefit, a net social loss is
generated.
b. In order to produce the efficient amount, output should be reduced until marginal
social cost and marginal benefit are equal.
c. At the efficient level of output there will usually be some pollution present.
III. MARKET FAILURE: IS GOVERNMENT ACTION NECESSARY?
A. Comments
1. When externalities are present there will be market failure. Market failure in this case
means that the market fails to produce an efficient outcome.
2. Government has passed numerous regulations in an attempt to correct the market
failures associated with pollution.
3. Some economists argue that instead of using regulation, government could rely on
Coase's solution and control pollution simply by establishing and enforcing property
rights to the natural environment.
4. Because of the bargaining involved, Coase's solution will only work if the number of
affected parties is small.
IV. AIR POLLUTION REGULATION: THE CLEAN AIR ACT
A. National Ambient Air Quality Standards (NAAQSs)
1. The NAAQSs are the upper limits permitted for concentrations of the six common air
pollutants described earlier in the chapter.
2. The NAAQSs represent threshold concentrations above which the EPA believes the
pollutant poses a significant risk to health.
3. The NAAQSs are applied uniformly across the country and must be met without
consideration of costs.
B. Emissions Limits
1. The EPA sets limits on the amounts of certain pollutants that may be emitted into the
atmosphere.
C. Restricted Technology
1. The Clean Air Act places several restrictions on, or specifies, the types of technologies
that may be used to achieve required pollution control standards.
82  Chapter 6/Air Pollution: Balancing Benefits and Costs
D. New Source Performance Standards
1. New commercial and industrial facilities - those established after a law is enacted - are
often subject to more stringent technology restrictions than old facilities - those
established before a law is enacted.
E. Prescribed Fuels
1. The Clean Air Act has established certain fuel requirements for motor vehicles.
F. Offset Requirements
1. Areas that do not meet ozone and carbon monoxide standards can permit new sources
of pollution only if ways are found to offset the increased pollution by reducing
pollutants from existing sources.
2. The offset must exceed the addition.
G. Emissions Trading
1. The offset policy has stimulated development of markets in emissions reduction
credits. Emissions reduction credits are earned by reducing emissions below the legally
required level.
2. Credits can be sold to firms seeking an offset for new sources of emission.
H. Prevention of Significant Deterioration
1. In order to prevent air quality from deteriorating, areas that were cleaner than the
NAAQSs when the Clean Air Act was established are also subject to regulation.
I. Monitoring and Compliance
1. State pollution control agencies are responsible for ensuring that NAAQSs are met.
V. EFFECTS OF THE CLEAN AIR ACT ON AIR QUALITY
A. Comments
1. The 1990 Clean Air Act Amendments require the EPA to conduct periodic,
scientifically reviewed studies to assess the benefits and costs of the Clean Air Act
(CAA).
2. Studies of the 1970-1990 period show that emissions of primary particulates were
reduced 75% in the first two decades, due to vigorous efforts to reduce visible
emissions from smokestacks. The projections for 1990-2010 indicate that most of the
easy reductions of particulates have been achieved. Sulfur dioxide emissions are
significantly lower in both periods, primarily due to electric generating plants installing
stack scrubbers and/or switching to lower sulfur fuels (low-sulfur coal and natural gas).
VI. THE ECONOMICS OF THE CLEAN AIR ACT: HAVE WE GONE TOO FAR?
A. Comments
1. Economists believe that government regulation is appropriate as long as the benefits
from regulation exceed the costs.
B. Benefits and Costs of the Clean Air Act, 1970 to 1990
1. Benefits
a. The lower emissions of pollutants attributable to the CAA from 1970 to 1990
translate into lower ambient concentrations of sulfur dioxide, nitrogen oxides,
particulate matter, carbon monoxide, ozone, and lead. These lower concentrations
yield a variety of benefits derived from improvements in human health, increased
visibility, reduced soiling of items and structures, increased worker productivity,
increased agricultural output, and ecological improvements.
Instructor's Manual  83
b. Lower concentrations of pollutants mean fewer:
1. cases of premature death, chronic bronchitis and other respiratory illnesses and
symptoms, hypertension, strokes, heart disease, and impaired IQs.
2. fewer hospital admissions.
2. Costs
a. Consumers, businesses, and governments all incurred higher costs to comply with
the Clean Air Act. The costs of providing goods and services (and their prices)
were higher due to requirements to install, operate, and maintain pollution control
equipment, to report regulatory compliance, and to invest in research and
development of new control technologies. Governments incurred costs of
designing and implementing regulations and monitoring regulatory compliance.
b. The EPA estimated total compliance costs for the 20-year period - adjusted for
inflation and time of occurrence - at approximately $523 billion.
c. The EPA has solid basis for arguing that, as of 1990, the regulations imposed by
the Clean Air Act had a net beneficial impact on the economy.
B. Benefits and Costs of the Clean Air Act, 1990 to 2010
1. The second issue that the EPA addresses in its benefit-cost analyses is whether the
1990 amendments to the CAA (additional regulations) are likely to yield benefits
greater than costs over the period, 1990 to 2010.
2. The EPA's estimates clearly indicate that the total benefits from regulation exceed the
total costs, but, by themselves, they cannot tell us if we have too little or too much
regulation.
VII. COST-REDUCING MEASURES
A. Emissions Tax
1. Use of an emissions tax can reduce the costs of achieving environmental quality.
2. An emissions tax regulates pollution by setting a price that polluters must pay per unit
of emission.
a. This forces polluters to bear the external cost associated with their actions.
b. Since costs are increased, polluters undertake less of the activity.
3. An emissions tax is superior to regulation.
a. Authorities do not have to specify who will be required to reduce pollution or
specify how much pollution must be reduced.
b. The cost of reducing pollution is minimized.
1. Polluters who can control pollutants more cheaply than paying the tax will
decrease emissions.
2. Polluters who cannot control pollutants more cheaply than paying the tax will
emit pollutants and pay the tax.
c. The tax induces firms to find new, low cost ways to reduce pollution.
4. An emissions tax will probably be borne by all parties (consumers and resource
owners) who benefit directly from the production of a good or service.
B. Marketable Pollution Permits
1. Pollution permits allow polluters to emit a certain amount of pollutants.
84  Chapter 6/Air Pollution: Balancing Benefits and Costs
2. Polluters who can control pollutants more cheaply can reduce emissions below the
standard, and then sell their excess permits to polluters who find it more expensive to
control pollutants, resulting in lower overall costs of pollution control.
The transferable permit is an effective regulatory tool, however, its main weakness is that
both buyers and sellers face transactions costs, that can be large enough to wipe out the
margin between what buyers are willing to pay and sellers are willing to accept.
C. Limiting Global Warming: Emissions Permits in an International Context
1. Concerns about global warming led to a United Nations conference in Kyoto Japan in
1997 in which industrialized countries agreed to reduce carbon dioxide emissions.
2. The Kyoto Protocol will be expensive for the United States; however, the costs of the
protocol could be minimized by using emission permits,
3. An international agreement on the use of pollution permits would reduce the
international cost of the agreement.
Answers to Review Questions
1. According to this chapter, what are the five most important air pollution problems?
Briefly discuss them.
The five major air pollution problems are poor quality of air in urban areas, acid rain, global
warming or the "greenhouse effect," ozone depletion, and threats by hazardous air pollutants.
Urban air quality is measured by comparing ambient air pollution levels with National
Ambient Air Quality Standards for each of six air pollutants: total suspended particulates,
sulfur dioxide, carbon monoxide, nitrogen dioxide, ozone, and lead. These standards were set
by the Environmental Protection Agency. When pollutants exceed these standards urban air
quality is presumed to place the population at an unacceptable level of risk. Poor air quality
can have adverse effects on human health, crops, livestock, property, safety, and the visual and
olfactory properties of the air.
Acid rain occurs when sulfur dioxide is chemically transformed into a weak sulfuric acid
solution that falls to the Earth as a part of natural precipitation. While the exact sources and
effects of acid rain are not known with certainty, it does appear that it has caused some lakes
and streams to become highly acidified. Further it may be the cause of the retarded growth and
increased mortality of forests in the eastern United States and Canada. It may also indirectly
affect human health through the contamination of fish and drinking water.
Global warming or the greenhouse effect refers to the gradual warming of the Earth due to an
increase in the level of greenhouse gases, gases such as carbon dioxide, which help the Earth to
retain heat from the sun. The greenhouse effect may eventually cause the melting of polar ice
caps. This would lead in an increase in the level of the oceans, which would threaten lives and
property along coastlines around the world. In addition, there may be significant weather
pattern changes, which could lead to changes in the location of the world's croplands.
Ozone in the Earth's atmosphere prevents harmful solar ultraviolet radiation from reaching the
Earth's surface. Ozone is also a greenhouse gas, which plays a role in warming the Earth's
surface. Nitrous oxides and chlorofluorocarbons emitted into the atmosphere act as catalysts,
which destroy ozone in the stratosphere. On the other hand, gases such as carbon dioxide and
methane increase the atmospheric concentration of ozone. While there is some uncertainty as
Instructor's Manual  85
to how these opposing forces will affect the ozone level, recent measurements indicate that
there have been significant decreases in the level of the ozone over Antarctica. Computer
models also indicate a significant decrease in the level of ozone. Because of the growth of
chlorofluorocarbons this trend is likely to continue and ozone depletion and its attendant health
problems will become more serious in the future.
Hazardous air pollutants are elements in air pollution that are toxic if inhaled or ingested in
small doses by man, animals, or plants. To date, the Environmental Protection Agency has
issued standards and regulations for only a small number of these toxins; however, it will have
to move rapidly on this problem in order to comply with the Clean Air Act Amendments of
1990. Evidence linking these pollutants to harmful effects on human health, especially central
nervous system damage and cancers, has been the impetus for these regulations.
2. Explain the following concepts. Use specific examples if needed.
a. Marginal cost.
b. Marginal external cost.
c. Marginal social cost.
a. Marginal cost (MC) is the change in the producer's total cost brought about by the
production of an additional unit of a good or service. It is also known as marginal cost of
production. For example if production costs rise from $1,000 to $1,050 as one more unit
of a good is produced the marginal private cost is $50.
b. Marginal external cost (MEC) is the change in the cost to parties other than the producer or
buyer of a good or service due to the production of an additional unit of the good or
service. For example, suppose it costs the producer $50 to produce another unit of a good.
Suppose this production results in pollution, which causes $60 worth of damage to another
company's plant. The marginal external cost is $60.
c. Marginal social cost (MSC) is the change in society's total cost brought about by the
production of an additional unit of a good or service. It includes both marginal cost and
marginal external cost. For example, suppose it costs a producer $50 to produce an
additional unit of a good. Suppose that when the additional unit is produced pollution is
emitted which causes $25 worth of damage to the paint on your car. The marginal social
cost of production is the producer's cost plus the external cost, or $75.
86  Chapter 6/Air Pollution: Balancing Benefits and Costs
Price Per Barrel
($)
MSC
$45
MEC
S, MC
D
27.5
22.5
C
E
10
D, MB
Refined Oil Products
0
400 450
900
(Millions of Barrels)
Figure 6.1
3. "Generally we would not expect the efficient level of pollution to be zero." Using
graphical analysis, explain why this statement is true.
While production of a good may generate pollution and thereby impose a cost on society,
society also receives some benefit when it consumes the good. Because consumption results in
benefits we find that the efficient level of pollution is generally not zero. The following
example illustrates this idea.
The above figure illustrates constant MEC, or MECs that are the same at each quantity of
refined products. We assume this in order to simplify the example. In reality, the MEC of oil
refining probably increases as the quantity refined increases. The quantity of refined oil
products will be determined, as usual, by the intersection of the supply and demand or MC and
MB curves. Thus, 450 million barrels of refined products will be produced and sold at $22.50 a
barrel. This level of production creates external costs of $4.5 billion - 450,000,000 barrels
times MEC of $10 per barrel - or the area marked by the end points: O,$10,D, and E. The
MECs from the first 400 million barrels are entirely offset by buyers' willingness to pay for
both the costs of refining and the MECs associated with refining. This is indicated by the fact
that the demand or MB curve exceeds the MSC curve (remember, this curve includes all costs)
for all units up to 400 million barrels. For each barrel beyond 400 million, however, MSC
exceeds MB, or the social cost per barrel exceeds the benefits per barrel. This means that the
market will produce too many barrels of refined oil products - 50 million barrels to be exact.
Society will lose an amount equal to the area CDE, or $250 million, on these units. Economists
call this amount the efficiency loss from pollution. To eliminate these losses, the market would
have to clear at 400 million barrels, but it won't do so because it is in the interest of both
producers and buyers to ignore the costs of the pollutants emitted from oil refineries (they are
external to market transactions - remember).
It is important to recognize that when both the benefits from economic activity and the costs of
pollution are considered, the efficient level of pollution is not zero. The level of pollutants
associated with 450 million barrels of refined products is too much, but reducing it below the
Instructor's Manual  87
level associated with 400 million barrels would be too little because the social costs saved by
doing so would be less than the benefits sacrificed. Social costs saved on each barrel are
indicated by the MSC curve and benefits sacrificed are indicated by the MB curve. Clearly, for
units less than 400 million, the amount sacrificed (MB) exceeds the costs saved (MSC).
4. Suppose that a market for refined oil products is described by the following data:
Suppose, also, that there are external costs of $1.00 per gallon associated with each gallon
produced.
Price Per Gallon
Quantity Demanded
Quantity Supplied
(Gallons)
(Gallons)
$2.00
0
20,000
$1.80
2,000
18,000
$1.60
4,000
16,000
$1.40
6,000
14,000
$1.20
8,000
12,000
$1.00
10,000
10,000
$0.80
12,000
8,000
$0.60
14,000
6,000
$0.40
16,000
4,000
$0.20
18,000
2,000
$0.00
20,000
0
Illustrate and determine the following:
a. The equilibrium quantity of refined oil products
b. The efficient quantity of refined oil products
c. Total costs of pollution
d. Efficiency losses from pollution
88  Chapter 6/Air Pollution: Balancing Benefits and Costs
a.
The above diagram is a graphical representation of the information given. The equilibrium
quantity of refined products is 10,000 gallons. This is the intersection of MC and MB.
b. The efficient quantity of refined oil products is 5,000 gallons, the intersection of MSC and
MB.
c. At the equilibrium level of production, we produce 10,000 gallons at $1 per gallon. At this
level, the external cost of production is also $1 per gallon. Thus, the equilibrium level of
production creates external costs of $10,000 (1x10000), which is the total cost of pollution.
d. For each gallon beyond 5,000, MSC exceeds MB, or the social cost per gallon exceeds
the benefits per gallon. This means that the market will produce too many gallons of
refined oil products - 5,000 gallons to be exact. Society will lose an amount equal to the
area ABC, or $2,500, on these units. This is the amount of the efficiency loss from
pollution.
5. Using the diagram you have created for your answer to question 4, identify
a. the quantity that would be produced if oil refiners (producers) were given property
rights to the environment
b. the quantity that would be produced if victims of pollution (victims) were given
property rights to the environment
c. the maximum amount that victims would pay producers to reduce production (and
pollution) and the minimum amount that producers would accept
d. the maximum amount that producers would pay victims to increase production and
the minimum amount that victims would accept
Instructor's Manual  89
a. If producers had the right to use the natural environment for waste disposal, they will
choose (as above) to produce at 10,000 gallons, where S=D or MC=MB.
b. If property rights were bestowed on the victims of pollution 5,000 gallons of oil products
would be produced (MSC=MB).
c. If production was at 10,000 gallons, the maximum amount that victims of pollution would
be willing to pay oil refiners for reducing pollution is equal to the damages they suffer
from pollution, or MSC minus MC ($1 per gallon). In order to reduce pollution, producers
would have to reduce production of refined oil products. If they reduced production below
10,000 gallons, they would save costs equal to the MC of each barrel, but they would also
sacrifice revenues equal to the amount they could charge for each unit. The amount they
could charge is the same as the amount buyers are willing to pay, or the MB on each unit.
Thus, they would be willing to reduce pollution only if they received the difference
between what they could charge, MB, and what they would save, MC. Starting at 10,000
gallons, the victims of pollution are willing to pay more per gallon to have production
reduced (the distance between MSC and MC) than the minimum amount required as
compensation by producers (the distance between MB and MC). This is the case for all
gallons between 10,000 and 5,000.
Below 5,000 gallons, however, the minimum compensation required for reducing
production (MB-MC) exceeds the maximum victims will pay (MSC-MC). In theory, then,
if victims could bargain freely with producers, they could pay producers enough to reduce
production to the efficient level.
d.
If we start with a clean environment or zero pollution , and zero production of refined oil,
how much are producers willing to pay victims for the right to produce (and pollute) and
how much compensation will victims require from producers?
The maximum amount that producers would be willing to pay victims for the right to
produce a unit of refined oil products is the difference between MB and MC - the
difference between the maximum price they could charge buyers if they increased
production by an additional unit and the cost of producing each unit. The minimum amount
that victims would accept is MEC - the value of the damages they would suffer from each
unit produced.
The maximum amount that producers would be willing to pay (MB-MC) exceeds the
minimum amount that victims would accept (MSC-MC) for all units up to 5,000. Thus, if
producers could bargain freely with victims, they could pay them enough to secure the
right to increase production to the efficient level.
6. What are the principal features of the Clean Air Act?
The Clean Air Act has established National Ambient Air Quality Standards (NAAQSs). These
are the upper limits for permissible concentrations of the six common air pollutants. They
represent threshold concentrations above which the EPA believes the pollutant poses a
significant risk to health.
The law also limits the amounts of certain pollutants that may be emitted into the atmosphere.
The 1990 amendments to the Clean Air Act also require the EPA to establish technology-based
90  Chapter 6/Air Pollution: Balancing Benefits and Costs
limits on emissions of 189 toxic chemicals and limit the emissions of substances that produce
acid rain.
The Clean Air Act requires that certain technologies be used to achieve the established
standards. For example, new stationary sources of pollution in ozone non-attainment areas
must use technologies that produce the Lowest Achievable Emissions Rate (LAER). Existing
stationary pollution sources in these areas must install Reasonably Available Control
Technology (RACT). New air toxin regulations require the use of Maximum Achievable
Control Technology (MACT).
The Clean Air Act has certain fuel requirements for mobile sources of pollution. Gasoline
stations in non-attainment carbon monoxide areas must sell oxygenated gasoline. Areas that
violate the ozone standards most frequently must increase their reliance on alternative fuels.
Areas that fail to meet the ozone and carbon monoxide standards can permit new major sources
of pollution only if ways are found to offset the increased pollution by reducing pollution from
existing sources by an amount greater than the addition. This "offset policy" has resulted in
emissions trading.
In order to maintain air quality in areas that complied with the NAAQSs when the Clean Air
Act was passed, limits on permissible reductions in air quality in these areas have been
established. The limits are stricter for the areas that started with better air quality.
State pollution control agencies are responsible for ensuring that NAAQSs are met. State
implementation plans (SIPs) detail how these standards are to be meet.
7. Has the Clean Air Act improved air quality? Explain.
Studies of the effects of the Clean Air Act (CAA)on air quality shows that for 1970-1990
period, emissions of primary particulates were reduced 75 percent in the first two decades, due
to vigorous efforts to reduce visible emissions from smokestacks. The projections for
1990-2010 indicate that most of the easy reductions of particulates have been achieved. Sulfur
dioxide emissions are significantly lower in both periods, primarily due to electric generating
plants installing stack scrubbers and/or switching to lower sulfur fuels (low-sulfur coal and
natural gas). Nitrogen oxide emissions were reduced during the 1970-1990 time period mostly
because of the installation of catalytic converters and other technologies on motor vehicles.
Caps on nitrogen oxide emissions from electric generating plants account for most of the
reduction expected in this pollutant in 1990-2010. The reduction in volatile organic compound
(VOC) emissions, 1970-1990, was due primarily to the application of motor vehicle emissions
control technologies. This is still the primary source of VOC reductions in 1990-2010,
although there is significant assistance in the future from commercial sources. Most of the
reductions in carbon monoxide emissions over the 40-year period are also attributable to motor
vehicle emissions control technologies. Lead emissions reductions were due largely to the
phase-out of leaded gasoline.
Since 1990, the EPA has taken further steps to reduce hazardous air pollutants. Until 1990, the
EPA had issued emission standards for only 9 air pollutants. Currently, standards for over 100
toxic air pollutants have been identified. The goal is to reduce pollutants by a million tons per
year.
Instructor's Manual  91
8. Has the U.S. gone “too far” in reducing air pollution? Explain, citing relevant evidence.
Society certainly reaps many benefits from the improved environmental quality associated with
the activities of the EPA. The variety of benefits derived from improvements in human health,
increased visibility, reduced soiling of items and structures, increased worker productivity,
increased agricultural output, and ecological improvements.
Improvements in human health are the most important source by far of the benefits estimated
by the EPA. Lower concentrations of pollutants mean fewer: (1) cases of premature death,
chronic bronchitis and other respiratory illnesses and symptoms, hypertension, strokes, heart
disease, and impaired IQs, and (2) fewer hospital admissions. For the economist, however, an
activity is not justified simply because it produces measurable benefits. The relevant question
is whether or not the activity produces net benefits, or benefits over and above costs.
Consumers, businesses, and governments all incurred higher costs to comply with the Clean
Air Act. The costs of providing goods and services (and their prices) were higher due to
requirements to install, operate, and maintain pollution control equipment, to report regulatory
compliance, and to invest in research and development of new control technologies.
Governments incurred costs of designing and implementing regulations and monitoring
regulatory compliance. The EPA estimated total compliance costs for the 20-year period adjusted for inflation and time of occurrence - at approximately $523 billion. However, the
EPA argues that, as of 1990, the regulations imposed by the Clean Air Act had a net beneficial
impact on the economy.
9. Briefly explain why an emissions (Pigovian) tax reduces the cost of achieving cleaner air,
using the example of the four plants developed in the chapter.
One of economists' favorite solutions to pollution is an excise tax on emissions of pollutants,
commonly called a Pigovian tax after its originator, the late British economist A. C. Pigou. An
emissions tax regulates the level of pollution by establishing a price that emitters must pay per
unit of emissions.
A numerical example will show how an emissions tax works and how it can lower the costs of
achieving a cleaner environment. Suppose that 4 coal-fired electric generating plants, each
owned by a different firm, are initially unregulated. Each plant emits four tons of sulfur dioxide
per day. Each of the plants could eliminate its sulfur dioxide emissions, but at widely varying
costs per ton, as indicated in the following table. The variation in cost per ton reflects factors
such as differences in age of plant and access to low-sulfur coal.
Suppose now that the regulators have determined that if total emissions are greater than 8 tons
there will be unacceptable harm to humans, plants, structure, animals, etc. To achieve this goal,
they simply limit each plant to 2 tons and monitor emissions to make sure that they do not
exceed two tons. In order to comply with the limit each plant is forced to reduce pollutants by 2
tons. The cost to them of doing this is indicated in the table in the columns labeled MAC. MAC
stands for marginal abatement cost. In the language of environmental economists, a ton that is
abated is not emitted. Thus, MAC is the cost of not emitting, or eliminating, each successive
ton of pollutants. With the 2-ton limit enforced, each plant abates 2 tons. This costs plant A
$300, Plant B $600, Plant C $900, and Plant D $1200, as indicated in row 6 of the table. Total
abatement cost (TAC) is the sum of these costs, or $3,000 per day.
92  Chapter 6/Air Pollution: Balancing Benefits and Costs
At this point the EPA's chief economist comes forward and suggests a way to reduce TAC. He
argues that the government can achieve the same level of abatement (8 tons), but at lower
TAC, if it lets the plants emit what they want, but at the cost of a tax of $500 per ton for each
ton that they emit. Each plant will now abate a ton only if the MAC of doing so is less than the
tax. If the MAC exceeds the tax they will not abate, but emit and pay the tax. Applying this
decision rule to the data in the table, we find that the responsibility for abatement shifts to the
plants with the lowest MAC; Plant A abates 2 more tons and Plants C and D abate 1 fewer ton
each. TAC falls from $3000 per day to $2300 per day as a consequence. The owners of plants
B and C are happy; they experience a reduction in costs, including both abatement costs and
taxes ($100 for Plant C after taxes and $300 for Plant B after taxes). Government officials are
happy, as well; they achieve their emissions objective and collect tax revenues of $1000 that
they can use for other government programs or to reduce other taxes. The owners of Plant A
are likely to be unhappy; they experience an increase in abatement costs.
10. Briefly explain why marketable pollution permits reduce cost of achieving cleaner air,
using the example of four plants developed in the chapter.
MAC
MAC
MAC
MAC
Plant A
Plant B
Plant C
Plant D
First Ton Abated (MAC1)
$100
$200
$300
$400
Second Ton Abated (MAC2)
$200
$400
$600
$800
Third Ton Abated (MAC3)
$300
$800
$900
$1200
Fourth Ton Abated (MAC4)
$400
$1200
$1200
$1600
Tons Abated With Uniform
2
2
2
2
$300
$600
$900
$1200
4
2
1
1
$1000
$600
$300
$400
TAC
Emissions Limit of 2 Tons
Total Cost of Abatement
$3000
With Uniform Emissions
Limit of 2 Tons
Tons Abated With Tax of
$500 Per Ton Emitted
Total Cost of Abatement
With Tax of $500 Per Ton
Emitted
$2300
Instructor's Manual  93
MAC
MAC
MAC
MAC
Firm A
Firm B
Firm C
Firm D
First Ton Abated (MAC1)
$100
$200
$300
$400
Second Ton Abated (MAC2)
$200
$400
$600
$800
Third Ton Abated (MAC3)
$300
$800
$900
$1200
Fourth Ton Abated (MAC4)
$400
$1200
$1200
$1600
Tons Abated With 2
2
2
2
2
$300
$600
$900
$1200
Maximum Amount Would Pay for
$200
$400
$600
$800
1st Permit
(MAC2)
(MAC2)
(MAC2)
(MAC2)
Minimum Amount Would Accept
$300
$800
$900
$1200
for 1st Permit (MAC3)
(MAC3)
(MAC3)
(MAC3)
(MAC3)
Maximum Amount Would Pay for
$300
$400
$600
$400
Next Permit
(MAC3)
(MAC2)
(MAC2)
(MAC1)
Minimum Amount Would Accept
$400
$800
$900
$800
for Next Permit
(MAC4)
(MAC3)
(MAC3)
(MAC2)
Permits Sold
2
0
0
0
Permits Bought
0
0
1
1
Tons Abated With Transferable
4
2
1
1
$1000
$600
$300
$400
TAC
Non-Transferable Permits
Total Cost of Abatement With 2
$3000
Non- Transferable Permits
Permits
Total Cost of Abatement With
$2300
Transferable Permits
Suppose that the owners of Plant A have a lot of political influence and that they are successful
in stifling passage of legislation that authorizes the $500 pollution tax. Another economist steps
forward with another policy that she claims will accomplish the same things as the pollution
tax, but at no cost to any of the plants. She suggests that each plant simply be issued 2 permits,
each of which allows a Plant to emit 1 ton of pollutants, but that the owners of the permits be
allowed to sell them to others. She suggests, that is, the use of marketable pollution permits.
Now the permit owners have to decide whether to hold or sell. If they hold a permit they save
on abatement costs. If they sell a permit, they assume additional abatement costs. What will
they do? Their choices are outlined in the following table.
When the permits are issued, and before any exchange of permits takes place, each plant emits
2 tons of pollutants and abates 2 tons. TAC at this point is the same as it was in the pollution
tax case; namely, $3000 per day (line 6). With the possibility of exchange, or permit
94  Chapter 6/Air Pollution: Balancing Benefits and Costs
transferability, the owners of each plant must decide how much they are willing to pay for a
permit, if they contemplate buying, and how much they are willing to accept for a permit, if
they contemplate selling. There will be an exchange or transfer of permits if someone is willing
to pay more than someone else is willing to accept.
Let's work through the possibilities one permit at a time. Given the starting point of two tons
abated, the maximum amount that all plants would be willing to pay for another permit (the 1st
one traded ) is what it would cost them to abate the ton themselves. That is, they would pay no
more to emit the ton (buy a permit) than the MAC of that ton - i.e., the MAC of the 2nd ton
abated. The minimum amount that they would accept is the MAC to them of the third ton; this
is what it would cost them for abatement if they sold a permit. Under these conditions, Plant A
will sell a permit to Plant D at some price between $300 and $800. Whatever they may agree
to in this range will make both parties better off if the exchange is made. Once the exchange
has been made, Plants A and D have to make a new calculation. Plant A is now abating 3 tons
and Plant D is now abating 1 ton. Plant A is now willing to pay no more for another permit
than the MAC, to them, of the third ton. Plant D is now willing to pay no more than the MAC,
to them, of the first ton. Plants B and C are still willing to pay the MAC, to them, of the second
ton. Plant A is willing to accept no less for a permit than the MAC of the fourth ton, Plants B
and C are still willing to accept no less than the MAC of the third ton, and Plant D is willing to
accept no less than the MAC of the second ton. Under these conditions, Plant A will sell
another permit, this time to Plant C.
The possibilities for exchange have now been exhausted. Plant A ends up abating 4 tons, Plant
B - 2 tons, Plant C - 1 ton, and Plant D - 1 ton. This is the same outcome as would be achieved
with a pollution tax of $500 per ton, and the TAC is also the same as in that case. All parties,
except the government, are as well off, or better off, than they were when no exchange of
permits took place.
In spite of their apparently equivalent ability to reduce TAC, regulators in this country have
opted for transferable permits over pollution taxes. In a fashion similar to our example, the
EPA has issued emissions permits for sulfur dioxide to electric generating plants in two phases
of a program to reduce acid rain. These permits allow electric generating plants in the
aggregate to emit only one-half of the sulfur dioxide that they were emitting before the
program was initiated. The EPA estimates that the exchange of sulfur dioxide permits for
money will save $1 billion in costs (out of $5 billion) of complying with the acid rain
provisions of the Clean Air Act. Economists have hinted, also, at large potential savings from
using transferable permits for emissions of carbon dioxide and toxic chemicals.
The transferable permit is an effective regulatory tool, but it is not perfect. Its Achilles heel is
transactions costs - the costs of finding willing buyers and sellers and negotiating mutually
acceptable prices for emissions permits. Both buyers and sellers face transactions costs, and
they can be large enough to wipe out the margin between what buyers are willing to pay and
sellers are willing to accept.