Environmental Protection Chapter 13

The Environmental Threat  Pollution impairs health, reduces life expectancy, and thus reduces labor- force activity and output.  It entails real costs, as measured by impaired health, reduced life spans, and other damages.

Air Pollution  Smog is only one form of air pollution.

Acid Rain  Sulfur dioxide (SO 2 ) is an acrid, corrosive, and poisonous gas created when high-sulfur fuels are burned.

Smog  Nitrogen oxides (NO X ), another ingredient in the formation of acid rain, are also a principal ingredient in the formation of smog.

The Greenhouse Effect  Excess buildup of carbon dioxide (CO 2 ) is creating a gaseous blanket around the earth.  The potential effects of this blanket are intensely debated.

Water Pollution  Water pollution is another environmental threat.

Organic Pollution  The most common form of water pollution comes from the disposal of organic wastes from toilets and garbage disposals.  Inadequate treatment systems often result in the closure of waterways and beaches.

Thermal Pollution  Thermal pollution is an increase in the temperature of waterways brought about by the discharge of steam or heated water.

Solid-Waste Pollution  Most solid wastes originate in agriculture and mining.  Solid waste originating in residential and commercial use is considered dangerous because it accumulates where people live.

Pollution Damages  Some monetary measure of environmental damage is important to our decision making.  We won’t get clean air unless we spend resources to get it.

Assigning Prices  Economists can estimate the dollar value of damage by assessing the economic value of lives, forests, lakes, and other resources.  It is difficult to measure the value of intangibles like lost views of sunsets, wildlife, and recreation opportunities.

Cleanup Possibilities  The EPA estimates that 95 percent of current air and water pollution could be eliminated by known and available technology.

Market Incentives  Market incentives play a major role in pollution behavior.

The Production Decision  Business managers seeking to maximize profit will produce the rate of output where MR = MC. Production decision – The selection of the short-run rate of output (with existing plant and equipment).

The Efficiency Decision  The efficiency decision requires a producer to choose that production process that minimizes costs for any particular rate of output. Efficiency decision – The choice of a production process for any given rate of output.

Cost of Pollution Abatement  The efficiency decision does not lead to a low production of pollution.  Pollution abatement can be achieved, but only at significant cost to the producer.

Cost of Pollution Abatement  The behavior of profit-maximizers is guided by comparisons of revenues and costs, not by philanthropy, aesthetic concerns, or the welfare of the environment.

Profit Maximization in Electric Power Production Price = MR A MC 1 ATC 1 Profit Price or Cost (dollars per kilowatt-hour) 0 Quantity (kilowatt-hours per day) 1000 Using cheap but polluting process P = MR A MC 2 ATC 1 Profit 0 Quantity (kilowatt-hours per day) 1000 B MC 1 ATC 2 Using more expensive but less polluting process Price or Cost (dollars per kilowatt-hour)

Market Failure: External Costs  People tend to maximize their personal welfare, balancing private benefit against private cost.  They ignore costs that are external to them.  External costs are costs of a market activity borne by a third party.

Externalities in Production  Whenever external costs exist, a private firm will not allocate its resources and operate its plant in such a way as to maximize social welfare.  If pollution costs are external, firms will produce too much of a polluting good.

Externalities in Production  External costs exist when social costs differ from private costs. External costs are equal to the difference between the social and private costs. External costs = Social costs – Private costs

Externalities in Production  Social costs are the full resource costs of an economic activity, including externalities. Private costs are the costs of an economic activity directly borne by the immediate producer or consumer (excluding externalities).

Externalities in Production  The market does not allocate resources efficiently when external costs are present.  This is a case of market failure. Market failure – An imperfection in the market mechanism that prevents optimal outcomes

Market Failure Social MCPrivate MC Price (= MR) B A External cost Price or Cost (dollars per unit) Quantity (units per time period) 0qSqS qPqP

Externalities in Consumption  A consumer, like a producer, tends to maximize personal welfare.  When people use vacant lots as open dumps, the polluter benefits by substituting external costs for private costs.

Regulatory Options  There are two general strategies for environmental protection. Alter market incentives in such a way that they discourage pollution. Bypass market incentives with some form of regulatory intervention.

Market-Based Options  Market incentives can be used to reduce or eliminate the divergence between private and social costs.

Emission Charges  An emission charge is a fee imposed on polluters, based on the quantity of pollution.  An emission charge increases private marginal cost and encourages lower output and cleaner technology.

Emission Charges  An emission charge might persuade firms to incur higher fixed costs. If emission charges are high enough, firms will install new technology to avoid the charges.

Emission Fees Fee = t MC + fee Price q1q1 q0q0 0 Price or Cost (dollars per unit) Quantity (units per time period) Private MC

Recycling Materials  A producer has no incentive to use recycled materials unless they offer superior cost efficiency and greater profits.  A bonus that emission charges offer is an increased incentive for the recycling of materials.

Higher User Fees  Raising the price consumers pay for scare resources encourages them to use less.

“Green” Taxes  An efficient way to control pollution is to make those who cause it bear some of the costs through “green” taxes.  “Green” taxes run the gamut from retail taxes on gasoline to landfill charges on waste disposal.

Pollution Fines  Imposing fines or liability for cleanup costs changes the incentive structure for firms.

Tradable Pollution Permits  Tradable pollution permits let firms purchase the right to continue polluting.  The key to the success of polluting permits is that they are bought and sold among private firms.

Tradable Pollution Permits  The system starts with a government-set standard for pollution reduction.  Firms that reduce pollution by more than the standard earn pollution credits which the may sell to other firms.

Tradable Pollution Permits  The principal advantage of pollution permits is their incentive to minimize the cost of pollution control.  Entrepreneurs now have an incentive to discover cheaper methods for pollution abatement.

Pricing Pollution Permits

Command-and-Control Options  With the command-and-control option, the government commands firms to reduce pollution and then controls the process for doing so.  Excessive process regulation may raise the costs of environmental protection and discourage cost-saving innovation.

Command-and-Control Options  When process regulation raises the cost of environmental protection, we have government failure. –Government failure – Government intervention that fails to improve economic outcomes.

Central Planning  Some of the worst evidence of government failure exists in the most regulated economies.  Government-directed production isn’t more environmentally-friendly than market-directed production.

Balancing Benefits and Costs  Protecting the environment entails costs as well as benefits.

Opportunity Costs  The use of our scarce resources to clean the environment involves an opportunity cost. Opportunity cost – The most desired goods or services that are foregone in order to obtain something else.

Opportunity Costs  The environmental expenditures contemplated by present environmental policies represent only 1-3 percent of total output.

The Optimal Rate of Pollution  Optimal rate of pollution is the rate of pollution that occurs when the marginal social benefit of pollution control equals its marginal social cost. Optimal rate of pollution := Marginal cost of pollution abatement Marginal benefit of pollution abatement

The Optimal Rate of Pollution  A totally clean environment is not economically desirable. The costs of environmental protection are substantial and must be compared to the benefits.

Cost-Benefit Analysis  Marginal analysis tells us that a zero- pollution goal isn’t economically desirable.  Some studies suggest the cost/benefit ratio is extraordinarily high.

Who Will Pay?  Whether producers or consumers pay the cost of reducing pollution depends on how much competition exists in the polluting industry and the price elasticity of demand.

Who Will Pay?  If producers can pass the cost of pollution control along to the consumer, higher prices reduce pollution in two ways: –Higher prices help to pay for pollution-control equipment. –Higher prices encourage consumers to buy less polluting goods.

The “Greenhouse” Threat  Some scientists worry about the carbon emissions we are now spreading into the atmosphere.  They warn that CO 2 is warming the earth’s atmosphere and predict the polar caps will melt, continents will flood, and weather patterns will go haywire.

The Green House Effect  Scientists fear there is a build-up of carbon dioxide might trap heat in the earth’s atmosphere, warming the planet.

The Skeptics  Other scientists are skeptical about both the temperature change and its cause.

Global Externalities  One thing is certain, CO 2 emissions are a global externality.  Without some form of government intervention, there is little likelihood that market participants will voluntarily reduce them.

Kyoto Treaty  In December of 1997, most of the world’s industrialized nations pledged to reduce CO 2 emissions.  The Kyoto Treaty encourages nations to develop a global system of tradable pollution permits to encourage cost efficiency.