Ch 14 Part III

2 Cost-Effective Policies for Fund Pollutants Defining a Cost-Effective Allocation

3 The damage caused by these pollutants depends on the amount entering the atmosphere

4 Ex: two emissions sources are currently emitting 15 units each for a total 30 units. Assume further that the control authority determines that the environment can assimilate 15 units in total, so that a reduction of 15 units is necessary. How should this 15-unit reduction be allocated between the two sources in order to minimize the total cost of the reduction?

5 The graph measuring the MC of control for the first source from the left-hand axis (MC1) and the MC of control for the second source from the right-hand axis (MC2).

6 Note that a total 15-unit reduction is achieved for every point on this graph Each point represents some different combination of reduction by the two sources. Drawn in this manner, the diagram represents all possible allocations of the 15-unit reduction between the two sources.

7 The left-hand axis represents an allocation of the entire reduction to the second source, while the righthand axis represents a situation in which the first source bears the entire responsibility. All points in between represent different degrees of shared responsibility. What allocation minimizes the cost of control?

8 In the cost-effective allocation, the first source cleans up ten units, while the second source cleans up five units. The total variable cost of control for this particular assignment of the responsibility for the reduction is represented by area A plus area B.

9 Area A is the cost of control for the first source; area B is the cost of control for the second. Any other allocation would result in a higher total control cost. (Convince yourself that this is true!

10 The figure also demonstrates that the cost of achieving a given reduction in emissions will be minimized iff the MCs of control are equalized for all emitters. This is demonstrated by the fact that the MC curves cross at the cost-effective allocation.

12 Cost-Effective Pollution-Control Policies The cheapest method of control will differ among industries and among plants in the same industry. The selection of the cheapest method requires detailed information on the possible control techniques and their associated costs.

13 The government authorities responsible for meeting pollution targets are not likely to have this information (cheapest method) Regulation depends on cost Those who have the information (the plant managers) are not inclined to share it. Can the cost-effective allocation be found? The answer depends on the approach taken by the control authority.

14 1. Emissions Standards A traditional legal approach by imposing a separate emissions limit on each source Its called “command-and-control” approach

15 An emissions standard is a legal limit on the amount of the pollutant an individual source is allowed to emit

16 2. Emissions Charges A fee, collected by the government, levied on each unit of pollutant emitted into the air or water. The total payment any source would make to the government could be found by (fee x the amount of pollution emitted)

17 Emissions charges reduce pollution because paying the fees costs the firm money. To save money, the source seeks ways to reduce its pollution.

18 How much pollution control would the firm choose? A profit-maximizing firm would control, rather than emit, pollution whenever it proved cheaper to do so.

19 Ex: The level of uncontrolled emission is 15 units and the emissions charge is T. If the firm were to decide against controlling any emissions, it would have to pay T times 15, represented by area 0TBC.

20 MC Cost $$ Units of Emissions Controlled T AB D C Cost-Minimizing Control of pollution with Emission Charge

21 Is this the best the firm can do? No, since it can control some pollution at a lower cost than paying the emissions charge. It would pay the firm to reduce emissions until the marginal cost of reduction is equal to the emissions charge

22 The firm would minimize its cost by choosing to clean up ten units of pollution and to emit five units. At this allocation the firm would pay control costs equal to area 0AD and total emissions charge payments equal to area ABCD for a total cost of 0ABC This is clearly less than 0TBC (the amount the firm would pay if it chose not to clean up any pollution)

23 3. Cap-and-Trade To find the cost-minimizing allocation without going through a trial-and-error process In this system: all sources face a limit on their emissions and they are allocated (or sold) allowances to emit.

24 These can be distributed among the firms either by auctioning them off or by granting them directly to firms (an allocation referred to as “gifting”). the allowances are transferable; they can be bought and sold (permits more emissions)

25 Read Debate 14.1 p. 375 END of CH 14