POLLUTION TAX
Using the paper market as an example:
• Paper mills generate chemical wastes as
part of their production process and dump
some of these wastes into rivers.
• If a city downstream was required to treat
the river water to make it safe for drinking,
it might impose a pollution tax to cover the
cost of additional water treatment.
POLLUTION TAX
• The paper market is a market that
generates spillover costs.
• Another word for spillover cost is
external cost.
• A pollution tax internalizes the
externality.
• If the firm pays $4 per gallon of waste,
the cost of polluting the river is
internal to the firm, not external.
FIRM’S RESPONSE TO
POLLUTION TAX
• Most polluting firms can control the
amount of polluting waste they dump
into the environment;
• As a firm continues to decrease waste,
it becomes progressively more
expensive to do so.
COST PER TON OF PAPER WITH VARYING
AMOUNTS OF POLLUTION
Waste
per ton
5
4
3
2
1
0
Production Cost
per ton
$60
$61
$64
$71
$86
$116
Tax Cost
per ton
$20
$16
$12
$8
$4
$0
Total Cost
per ton
$80
$77
$76
$79
$90
$116
COST PER TON OF PAPER WITH VARYING
AMOUNTS OF POLLUTION
Waste
per ton
5
4
Production Cost
per ton
$60
$61
Tax Cost
per ton
$20
$16
Total Cost
per ton
$80
$77
3
$64
$12
$76
2
1
0
$71
$86
$116
$8
$4
$0
$79
$90
$116
MARGINAL PRINCIPLE
Increase the level of activity if its
marginal benefit exceeds its marginal
cost, but reduce the level if the
marginal cost exceeds the marginal
benefit. If possible pick the level at
which the marginal benefit equals the
marginal cost.
MARKET EFFECTS OF A POLLUTION
TAX
• The original price of $60 just covered the cost of
producing paper without the pollution tax;
• The tax increases the cost of producing paper
because the typical firm pays some pollution tax
and incurs some costs when it cuts back its
pollution;
• Since old price is not high enough to cover higher
production costs, some firms leave the market;
• The supply curve shifts left: at each price a
smaller quantity of paper will be supplied;
• The leftward shift of the supply curve increases
the equilibrium price of paper (point i to point f).
MARKET EFFECTS OF A POLLUTION TAX
Price per ton
of paper $$
Supply Curve with $4
pollution tax
f
68
60
i
Initial Supply
Demand
80
100
Tons of paper per day
MARKET EFFECTS OF A
POLLUTION TAX
• Like other taxes, a pollution tax is
partially shifted to consumers in the
form of a higher price;
• When consumers face the full cost of
producing paper, they decide to
consume less of it.
THE MARKET EFFECTS OF A POLLUTION
TAX
How does the pollution tax affect the
volume of waste dumped into the river ?
1. Abatement
There is less waste per ton of paper (3 gallons
instead of 5 ).
2. Lower Output
The industry produces less paper (only 80 tons
per day instead of 100).
COMMAND AND CONTROL
REGULATION POLICY
The government commands each
firm to produce no more than a
certain volume of pollution and
controls the firm’s production
process by forcing the firm to use
a particular pollution-control
technology.
COMMAND AND CONTROL
REGULATION POLICY
The mandated abatement technology
is unlikely to be the most efficient
technology for two reasons:
• The regulatory policy specifies a single abatement
technology for all firms; while efficient for one
firm, this may not be efficient for others.
• The regulatory policy decreases the incentives to
develop more efficient abatement technologies.
MARKET EFFECTS OF REGULATION BY
COMMAND AND CONTROL
Price per ton
Supply Curve with
of paper $$
regulation
f
74
Initial Supply
i
60
Demand
70
100
Tons of paper per day
COMMAND AND CONTROL
REGULATION
• The mandated technology will be
less efficient and more costly than
the technology developed under a
pollution tax;
• The supply shift resulting from the
regulatory policy will be larger than
the supply shift from the pollution
tax.
COMMAND AND CONTROL
REGULATION
Everyone will be unhappy with command
and control policy:
• Consumers will be unhappy because the
price is higher ($74 instead of $68);
• Firms will be unhappy because there is
less paper (70 tons per day instead of 80
with the tax).
• Environmentalists will be unhappy because
there is more pollution (280 gallons per day
instead of 240).
ADVANTAGES OF POLLUTION TAX AND
COMMAND AND CONTROL POLICY
POLLUTION TAX
COMMAND & CONTROL
• The money raised from • The policy specifies
pollution tax could be
how much waste each
used to cut other taxes
firm can produce, so
or increase spending on
we can predict the
public programs
total volume of waste
MARKETABLE POLLUTION
PERMITS
The government picks a target
pollution level for a particular area,
issues just enough pollution permits to
meet the pollution target, and allows
firms to buy and sell the permits.
The key innovation is that these
permits are marketable.
MARKETABLE POLLUTION
PERMITS
PAPER INDUSTRY EXAMPLE:
1.There are 100 paper mills in the market,
each producing 1 ton of paper per day and
initially generate 5 gallons of waste per
day;
2. Half the paper mills can abate the pollution
at a relatively low cost;
3. Half the paper mills have relatively high
abatement costs.
ABATEMENT COSTS: LOW-COST
VERSUS HIGH-COST FIRM
Waste
Production cost
per Ton
per Ton:
(gallons)
Low Cost
5
$60
4
$61
3
$64
2
$71
1
$86
0
$116
Production cost
per Ton:
High Cost
$60
$67
$82
$112
$172
$300
ABATEMENT COST: LOW-COST
VERSUS HIGH-COST FIRM
Suppose government decides to decrease
the volume of waste to 400 gallons per day:
• The government issues 4 marketable
permits to each of the 100 paper firms;
• If a particular firm wants to generate 5
gallons of waste per day, it can buy a fifth
permit;
• The firm that sells one of its permits can
only generate 3 gallons of waste per day.
ABATEMENT COST: LOW-COST
VERSUS HIGH-COST FIRM
Each low-cost firm will sell a permit to
a high-cost firm:
1. Each high-cost firm is willing to pay up to $7 for a
permit. If a high-cost firm gets a fifth permit, it
can generate 5 gallons of waste and produce a
ton of paper for $60 instead of $67 with four
permits;
2. Each low-cost firm is willing to accept any
amount above $3, since if low-cost firm gives up
one permit, it can generate only 3 gallons of
waste. Its production cost would increase by $3
(from $61 to $64).
DIFFERENCES IN TOTAL ABATEMENT COSTS
Gallons
Abated
Abatement Costs
High-Cost Firms Low-Cost Firms Total
With
Trading
100
0
$200
$200
Without
Trading
100
$350
$50
$400
DIFFERENCES IN TOTAL ABATEMENT COSTS
With Trading
• Each high-cost firm will generate 5 gallons of waste and
spend nothing on pollution abatement;
• Each low-cost firm will generate 3 gallons of waste and
incur an abatement cost of $4 ($64 - $60);
• Total cost of cutting from 500 to 400 gallons waste is $200.
Without Trading
• Each high-cost firm incurs $7 to abate 1 gallon of waste:
production cost increases from $60 to $67. With 50 highcost firms, total abatement cost is $350 for these firms;
• Each low-cost firm incurs $1 to abate 1 gallon of waste:
production cost increases from $60 to $61. With 50 lowcost firms, total abatement cost for these firms is $50.
• The total cost under traditional permit policy is $400.
EXAMPLES OF MARKETABLE
PERMIT EXCHANGES
WHO
PAID
TO WHOM
Duquesne $3,750,000 Wisconsin Power
Light Co. ($250 / ton) and Light
Mobil Oil $3,000,000 Torrence, CA
Corp.
(earlier rights
from GM)
TO DUMP
15,000 tons of
sulfur dioxide
900 pounds of
reactive vapors
per day
• Another example is a firm in Los Angeles which
installed a new incinerator that decreased
hydrocarbon emissions by 100 tons per year and
offered to sell the rights to emit 100 tons of
hydrocarbons for $400,000.
GLOBAL WARMING
• Solar energy comes through the
atmosphere and heats the air near the
earth’s surface.
• Certain types of gases in the atmosphere
(called greenhouse gases) trap the heat
close to the earth’s surface.
• Unfortunately, we are pumping more of
these greenhouse gases into the
atmosphere, so the earth’s temperature is
increasing.
HOW DOES DESTRUCTION OF
TROPICAL RAIN FORESTS AFFECT
GLOBAL WARMING ?
1. If trees and plants are burned to clear
the land, the carbon stored in these
plants is converted into carbon
dioxide.
2. Once the forest is cleared, there is
less plant material to convert carbon
dioxide into stored carbon.
EFFECTS OF GLOBAL WARMING
• Total rainfall will increase, with some areas
getting more and others getting less;
• Increased carbon dioxide will make all
plants (including weeds) grow faster;
• Net effect on agriculture is likely to be
negative: expect less rainfall in areas with
fertile soil and more in areas with less
fertile soil;
• Increasing global temperatures will melt
glaciers and polar ice caps, increasing sea
levels.
CARBON TAX
• Economist’s response to global warming is
a tax on fossil fuels;
• Tax would force people who use fossil fuels
to pay the full cost (spillover cost) of using
them;
• spillover cost of a particular fuel depends
on how much carbon dioxide is released
into the atmosphere;
• Carbon tax for a particular fuel would be
determined by the fuel’s carbon content.
MARKET EFFECTS OF CARBON TAX ON COAL
Supply Curve with
carbon tax
Price per ton
of paper $$
t
42
Initial Supply
i
35
Demand
78
100
Tons of Coal per day
EFFECTS OF DIFFERENT CARBON TAXES
Tax per ton of carbon
Effect on price of coal
Tax per ton
Percentage increase
Effect on price of oil
Tax per barrel
Percentage increase
Effect on price of gasoline
Tax per gallon
Percentage increase
Percentage reduction in
greenhouse emissions
Total tax revenue per year
low tax
high tax
$5.00
$100.00
$3.50
10 %
$70.0
205 %
$0.58
2.8 %
$11.65
55 %
$0.014
1.2 %
10 %
$0.28
23 %
43 %
$10 billion
$125 billion
OZONE DEPLETION
• A layer of ozone in the upper atmosphere prevents most of
the sun’s harmful ultraviolet light from reaching the
surface of the earth;
• Ultraviolet light causes living cells to mutate, causing
– skin cancer,
– eye disease,
– death of marine organisms;
• Chlorofluorocarbons (CFCs), used in refrigeration, air
conditioning, spray products, etc..., were the culprit;
• The nations of the world have agreed to stop producing
CFCs altogether;
• The ban on CFCs will increase the equilibrium prices of
the goods that were produced with these chemicals.
ACID RAIN
• sulfur-dioxide emissions of coal-burning power
plants combined with nitrogen oxides and other
chemicals in the atmosphere to form acid rain;
• Rainfall downwind from the power plants changed
soil and water acidity, causing problems for trees,
fish, and other aquatic life;
• The Clean Air Act of 1990 established a system of
marketable pollution permits for sulfur dioxide:
– Each utility will receive enough permits to
generate 30% to 50% of the sulfur dioxide it had
produced 10 years earlier;
– The permit system will decrease sulfur dioxide
emissions by 10 million tons per year.
URBAN SMOG
• The result of mixing several pollutants, including
nitrogen oxides, sulfur dioxide, and volatile
organic compounds -- ground-level ozone;
• Smog causes health problems in human beings
and other animals, retards plant growth and
decreases agricultural productivity;
• The automobile is the most important source of
the pollutants that lead to smog;
• The Environmental Protection Agency currently
uses a command-and-control approach to
regulate automobile pollution;
• An alternative to the EPA policy is to levy an
annual pollution tax on each car.