The economists’ approach to Presenter: Brian Danley

 What problems are created when negative externalities exist in production and how can economics be used to approach these problems? Recall: what is the goal of the firm? But what about companies that care?

Teaser trailer: ”internalize” the externality.  How should quantitative environmental goals be set?  How to balance between socially beneficial production and socially harmful pollution?  After we determine the right balance how to acheive that solution? (cost minimization)

The Economics Model  Emission (utsläpp) function: z= k(q^n) Damage function: = A(u)  Static effects. The firm’s cost curve is private, but we can also calculate social costs in money as well.  Some kind of technology exists to reduce emissions but it is costly.  Firms in a competetive goods market. (what does that mean for profit maximization?)

A market optimum and a social optimum The standard supply and demand diagram. Is this market producing an efficient amount of the good? What are these curves, in mathematical terms?

Consumer and producer surplus analysis. Important! Negative externalities are modeled as costs and positive externalities are modeled as benefits for this kind of analysis. A market with a negative externality. Add in a new supply function (MSC= S + EC).

One possibility: direct state production  A government authority can take over production.  Normally this is done for more than strictly economic reasons. (healthcare)  Problems? We want a private market for many things, don’t we?

Anyone care for a smoke?

 Specific regulation: ”command and control” EX: Everyone must reduce emissions by X amount. Your preferences don’t matter. ○ Problems: goal setting, monitoring costs, EFFICIENCY in cost allocation (information)  Property rights (äganderätter) solution, Coase invariance theorm Depends on self interest of participants. ○ Requirements: rights are clearly and fully defined over the entire issue (no issues left out), rights are 100% transferrable, assigning the rights does not change the relative positions of power among the actors (income effect is negligable), the costs of organizing the trade and executing the trade are negligable (transaction costs are zero).

Issues with the property rights solution  free riding (individual utilities are private information)  monitoring will likely be easier and less costly, but it may be an issue still  MAIN PROBLEM: transaction costs (benefits of polluting are often concentrated while the costs are widely spread)  In a way, doesn’t society already own the right to not have a polluted environment?

Pigovian Tax (put a price on it)  What is really wrong with a restriction like ”everyone must reduce emissions by amount X?”  If the damage function is the same for all emissions sources, and there are 2 firms with different cost functions for reducing emissions, how would a ”price” on emissions affect the choices of each firm?

The nuts and bolts  MCr for firm 1 is: MCr = A(z)  MCr for firm 2 is: MCr = A(z^2)  With the same price on emissions (tax) the emission of each firm will be different. Which firm will emit less?  Graphical reasoning, then the math.

Marketable Permits, Transferrable Emission Rights (överlåtbara utsläppsrättigheter)  What if we decide not to put a regulation on price, but instead on quantity of emissions? Firms can trade these rights or permits between themselves. How will the outcome be different?  The graphical reasoning.  Which solution would firms prefer?

Comparison of taxes and permits.  If the benefits of pollution reduction are uncertain.  If the costs of emission reduction are uncertain.  If there is some kind of ecological threshold for the pollution.

Things to keep in mind…  It is hard to accurately figure out how the social cost curve is affected by environmental factors.  The more market power firms have, the more careful you should be about this intution.  Need flexability and ability to react to changes and possible errors in computation.

Go forth and do likewise… Figure out how to make it in the rational self interest of people, companies, or organizations to care about the effects of their actions.