Dr. Laura Dawson Ullrich March 25, 2014

Q per year $ MB MD MPC MSC = MPC + MD Q1Q1 Q* Actual output Socially efficient output b a c

Coase Theorem – Ronald Coase (1960)  A private solution can be reached if: Bargaining costs are low The owners of resources can identify the source of damages to their property and legally prevent damage  Government is still needed to define and enforce property rights  Difficulty typically arises with high bargaining costs. Lawyers, executives, etc. are involved

 Command and Control Policies  Standard regulation (e.g. you cannot use chemical X)  Highly inefficient, but very popular  Why??  Ignores differences in costs between producers and/or consumers Q per year $ MB MD MPC MSC = MPC + MD Q1Q1 Q* b a

 Primary air pollution act in the USA  Has been amended several times  Congress used command and control to set national air quality standards that were to be met independent of the costs of doing so  Established the Environmental Protection Agency (EPA)  Costs were estimated to exceed benefits in this case  Highly inefficient, as firms faced much different abatement costs

 Pigouvian Tax  Tax levied on each unit of a polluter’s output in an amount just equal to the marginal damage it inflicts at the efficient level of output.  The tax increases the marginal cost of production, and therefore, shifts the supply curve  Results in production at the socially optimal level  Additional benefit: tax revenue

Tax Revenue

 Subsidy  Can pay companies/people NOT to partake in externality causing activity  Can also result in the socially optimal level of production and/or consumption  Much less popular  Why? Increases profits May be seen as rewarding ‘bad’ behavior

 Permit Trading  Market-based system  Initially proposed in the USA in the early 1980s to control the market for Sulfur Dioxide and Nitrogen Oxides (cause of ‘acid rain’)  Passed as an amendment to the Clean Air Act in 1990  Program’s goal was to lower sulfur dioxide emissions from 18.9 million tons in 1980 to 8.95 million tons in  Outcomes were better than expected  Acid rain levels have dropped by 65%

 Permit Trading – How it Works  Government sets a cap on emissions  Permits are allocated to polluters Grandfathering Auction  Polluters have three options Option 1: Use permits (in other words, pollute) Option 2: Save permits to be used in the future Option 3: Sell the permit  This is efficient because those that can abate cheaply will do so and sell their permits to those whose costs are greater  Creates a market for pollution  It is possible for environmental groups to purchase and destroy permits

 Create a permit trading system for carbon emissions  Similar to SO 2 program but MUCH larger in scale  Benefits  Could significantly lower carbon emissions and slow the progress of climate change  Could accelerate the switch to alternative fuels  Issues  How do you distribute permits?  Increases in the prices of many goods  International nature of the environment

 European Union Emissions Trading System (EU ETS)  Began in 2005  Covers over 11,000 facilities  All EU countries participate, as do Norway, Liechtenstein and Iceland  Phase III began in 2013 – permits are now auctioned  Price of permits has been lower than expected (likely due to financial crises)  Results have been criticized.  Leakage??

 The international nature of environmental issues cannot be ignored  Getting countries to agree on something across the board is nearly impossible  Example: The Kyoto Protocol