Class 7
Environmental Policy Tools
http://www.agecon.purdue.edu/staff/shively/courses/AGEC406/index.htm
Possible Interventions
1. Moral suasion
2. Government provision of goods
3. Damage prevention
4. Command and control
5. Economic Incentives
Economic Incentives
1. Tax (per-unit penalty)
2. Subsidy (per-unit reward)
3. Transferable Permits (market-based)
Focus on case of negative externality
and compare:
1. Command and control (direct regulation)
2. Tax
3. Subsidy
Command and Control
Set limit on emission or specify technology
MAX
SMC = PMC + MD
PMC
PMB=SMB
QM
Q
Pigouvian Tax
Set tax = marginal damage rate
SMC = MC + tax
MC
Tax = MD
Q
Subsidy
Often used in conjunction with technology
MSC (Tech 1)
MSC (Tech 2)
MPC (Tech 2)
MPC (Tech 1)
Subsidy
Command and Control
Consists of government-specified rules and
regulations, often with fines and charges for
violations. Most effective:
1. When monitoring costs are high
2. When optimal emission is near zero
3. During random or emergency events
Drawback of C+C:
If marginal abatement costs are different for
different pollutors, then
C+C will lead to an
inefficient allocation of clean up burden
among different producers.
Marginal abatement cost function
Marginal abatement =
pollution reduction of one unit.
The marginal abatement cost (MAC) function
measures the dollar amount of the cost of
reducing pollution by one unit.
Marginal abatement cost function
Shape of curve depends on technology of clean-up
Cost
MAC
Marginal Abatement Cost
Total Abatement Cost
C1
E1
EU Emissions
Marginal damage function
Dollar measure of incremental
damage from pollution
Damages
MD
D
Total Damage
E
Emissions
Optimal level of pollution
Damages,
Costs
MAC
MD
Total Damage
Total Abatement Cost
E1
EU
Emissions
Socially inefficient (sub-optimal)
levels of pollution
Damages,
Costs
MAC
MD
Excess social
cost from too
much abatement
Excess social
cost from too
little abatement
E1
EU
Emissions
Advantages of Economic Incentives
1. In most cases economic incentives
will minimize the total costs of
abatement.
2. By penalizing polluting behavior
or rewarding clean behavior,
economic incentives tend to
encourage research into better
abatement measures.
Pollution tax
Goal: set tax = marginal damage cost
Why: encourage polluter to “internalize” the
externality
Key: Tax the externality, not the product.
Polluter behavior with tax
Costs
MAC = 10 - E
Potential Tax Payment
Tax=4
Tax Avoidance
T*Q=24
Actual Tax Payment
E1=6
EU=10
Emissions
Key points regarding tax
1. Tax achieves socially optimal level of
pollution
2. MAC may exceed MD for some levels of
pollution. Therefore, the optimal level of
pollution is likely to be greater than 0.
3. Individual polluters adjusts emissions to point
where MAC = tax, therefore MACs are equal
for all polluters, which minimizes total cost
of obtaining target level of pollution.
Tradable Pollution Permits
1975 the U.S. EPA started an Emissions
Trading Program to reduce air pollution.
Support for this market-based approach has
grown both among businesses and
environmentalists.
What is a tradable permit?
Flexible approach to reaching target level of pollution
Any source that reduces emissions more than required
receives an “emission reduction credit” (ERC).
ERCs can be used to satisfy emission targets at other
discharge points for which the MAC is higher.
ERCs can transferred or sold, thus allowing sources to
find the cheapest means to controlling emissions.
Policy context
ERC is “currency”
Policies governing use include:
Offset policy: firm uses ERC to continue
polluting at another source
Bubble policy: total emissions within “bubble”
are regulated, trade within is OK.
Emissions banking: firm can “stockpile” ERCs
Applications
Air pollution (1975)
Lead in gasoline (1982-1987)
CFCs and other ozone-depleting chemicals (1988-)
SO2 Acid rain (1993-)
Mobile sources (1993-)
Greenhouse gases (proposed)
Polluter behavior with regulation:
Specify 4 units of emission each
Costs
Costs
MAC = 10 - E1
MAC = 8 - 2 E2
C1=6
18
C2=0
E1=4
EU=10
E2=4
Polluter behavior with permit
1. Total Target Emission Level = 8,
so E1 + E2 = 8
2.
Set MAC1=MAC2 and solve.
10 - E1 = 8 - 2E2
10 - E1 = 8 - 2(8-E1)
10-8+16 = 3 E1
18 = 3 E1
6 = E1
Polluter behavior with permit:
firms determine allocation of emissions
Costs
Costs
MAC = 10 - E1
MAC = 8 - 2 E2
C2=4
C1=4
8
E1=6
4
EU=10
E2=2
EU=4
Key messages:
1. Target Emission Level is reached.
2. Total cost of abatement is lower
(12 vs. 18)
3.
Optimal allocation is reached
where firms equate MACs.
4.
Permits allow low-cost firms to
abate more than they otherwise would.
Implementation Problems:
1. Transaction costs
2.
Spatial considerations
3. Temporal considerations
4.
Market power
5.
Environmental justice (equity)