AGEC/FNR 406 LECTURE 17

Tradable Pollution Permits 1975 the U.S. EPA started an Emissions Trading Program to reduce air pollution. Support for this market-based approach has grown both among businesses and environmentalists.

What is a tradable permit? Flexible approach to reaching target level of pollution Any source that reduces emissions more than required receives an “emission reduction credit” (ERC). ERCs can be used to satisfy emission targets at other discharge points for which the MAC is higher. ERCs can transferred or sold, thus allowing sources to find the cheapest means to controlling emissions.

Policy context ERC is “currency” Policies governing use include: Offset policy: firm uses ERC to continue polluting at another source Bubble policy: total emissions within “bubble” are regulated, trade within is OK. Emissions banking: firm can “stockpile” ERCs

Applications Air pollution (1975) Lead in gasoline ( ) CFCs and other ozone-depleting chemicals (1988-) SO 2 Acid rain (1993-) Mobile sources (1993-) Greenhouse gases (proposed)

Polluter behavior with regulation: Specify 4 units of emission each E 1 =4 Costs MAC = 10 - E 1 C 1 =6 E 2 =4 Costs MAC = E 2 C 2 =0 E U =10 18

Polluter behavior with permit 1. Total Target Emission Level = 8, so E 1 + E 2 = 8 2. Set MAC 1 =MAC 2 and solve E 1 = 8 - 2E E 1 = 8 - 2(8-E 1 ) = 3 E 1 18 = 3 E 1 6 = E 1

Polluter behavior with permit: firms determine allocation of emissions E 1 =6 Costs MAC = 10 - E 1 C 1 =4 E 2 =2 Costs MAC = E 2 C 2 =4 E U =10 8 E U =4 4

Key messages: 1. Target Emission Level is reached. 2. Total cost of abatement is lower (12 vs. 18) 3. Optimal allocation is reached where firms equate MACs. 4. Permits allow low-cost firms to abate more than they otherwise would.

Implementation Problems: 1. Transaction costs 2. Spatial considerations 3. Temporal considerations 4. Market power 5. Environmental justice (equity)