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?) MCC MDC 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

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 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

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 MDC emissions controlled $$ use permits use charges Prevent large fluctuations in damage costs Prevent large fluctuations in control costs