Environmental Economics

Cost of Reducing Pollution Pollution Reduction MAC a CaCa PaPa Greater Abatement A Total abatement Costs =Area A $

Command and control Legislate emission levels –All firms required to reduce pollution to specific levels e f is maximum pollution Forced to cut in half (0.5e f ) What are costs of abatement?

Firm 1 $ Firm 2 Abatement Total abatement for firm 1 Total abatement for firm 2 $ (Low cost firm) (High cost firm) MAC 1 MAC 2.5e f C1C1 C2C2 (e f,0)(0,e f )

Firm 1 $ Firm 2 Abatement.5e f $ CeCe ab d f g C2C2 C1C1 Total abatement Costs = a+d+f+b+g

Taxes Instead of command and control, why not tax emission Requires continuous monitoring In this case, C e is per unit tax Two characteristics –Equal cost at the margin for both firms –Will show it holds total pollution constant to command and control levels

Firm 1 $ Firm 2 Abatement.5e f $ CeCe ab d f g C2C2 C1C1 Total abatement Costs = a+d+f+b+g

Firm 1 $ Firm 2 Abatement.5e f $ CeCe ab g C2C2 C1C1 Total abatement Costs = a+b+g CeCe e1e1 Total cost savings=d+f d f Taxes paid, Firm 1 Taxes paid, Firm 2

Firm 1 $ Firm 2 Abatement.5e f $ CeCe CeCe ab d f g C2C2 C1C1

Firm 1 $ Firm 2 Abatement.5e f $ CeCe CeCe ab d f g C2C2 C1C1 e1e1

Cap and trade Start with command and control levels –Receive permit to pollute 0.5e f –must abate 0.5e f However, you can increase pollution levels only if you purchase the right to pollute from another manufacturer Who would sell their right to pollute? Who would purchase?

Firm 1 $ Firm 2 Abatement.5e f $ CeCe CeCe ab d f g C2C2 C1C1 e1e1

Firm 1 $ Firm 2 Abatement.5e f $ CeCe CeCe ab d f g C2C2 C1C1 e1e1

Firm 2 –Willing to pay area d+f+b for the right to pollute more Firm 1 –Needs b to increase pollution Trade will take place Notice that both firms are better off Costs of a abatement have fallen by d+f