1. Economics of Environmental Policy

2. Environmental Policies
Decentralized Policies
Liability Laws and Property Rights
Moral Suasion
Command and Control
Emission Standards
Technology Standards
Incentive-Based Policies
Emission charges
Subsidies
Tradable discharge permits

3. Criteria for Evaluating Policies
Efficiency
Cost Effectiveness
Fairness
Incentives for Technological Improvements
Enforceability
Morality

4. Rational central planning is impossible
Efficiency
Maximum net benefits
Requires balancing MAC and MD
Decentralized……………….Centralized
Hayek’s critique
Rational central planning is impossible
Cost Effectiveness:
When damages (benefits) can’t easily be measured

5. Garden of Eden
Adam
Eve 12 9 3 5 4 8
Adam and Eve in the Garden of Eden, by Titian (c. 1550)

6. Which allocation would you choose?
Adam
Eve 12 9 3 5 4 8
Choice One
Choice Two
Choice Three
Choice Four
Choice Five
Tradeoff: Efficiency vs. Fairness ? 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

7. Distribution of Net Benefits
Fairness
Distribution of benefits/costs across regions, incomes, race, etc
Distribution of Net Benefits
Program
Total Cost
Total Benefits
Net Benefits
Low Income
High Income A 50
100 25 B 30 20 C
140 90 70 D 45

8. If you could impose any of the four Programs, which would you choose?
Program A
Program B
Program C
Program D
Distribution of Net Benefits
Program
Total Cost
Total Benefits
Net Benefits
Low Income
High Income A 50
100 25 B 30 20 C
140 90 70 D 45 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

9. Distribution of Net Benefits
If your choices were limited to Program C or Program A, which would you choose?
Program A
Program C
Distribution of Net Benefits
Program
Total Cost
Total Benefits
Net Benefits
Low Income
High Income A 50
100 25 B 30 20 C
140 90 70 D 45 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

10. Incentives for Technological Improvements
Shift the MAC curve down
MAC1
MD1
MAC2 E2 E1 E0
Emissions

11. Incentives for Technological Improvements
Incentives for private sector to innovate
Profit motive
New ideas are a public good
 undersupply problem
Pollution Control industry: “envirotech”
Driven by regulations and profit motive

12. Enforceability Enforcement is costly Reliance on self-reporting
Monitoring
Sanctioning
Courts
Fines
 Paradox of the Reluctant Enforcer

13. Moral Considerations Right vs. wrong Taxes vs. Subsidies vs. Permits
The Animal Liberation Front (ALF) carries out direct action against animal abuse in the form of rescuing animals and causing financial loss to animal exploiters, usually through the damage and destruction of property.

14. Decentralized Policies
Liability Laws
Property Laws
Voluntary action

15. Liability Law Polluters must compensate those harmed
Provides incentive to make careful decisions
“internalize the externality”

16. Which of the following situations would provide a system of liability rules the best chance for generating an efficient level of emissions?
many people are involved, causal links are clear, and damages are difficult to measure.
few people are involved, causal links are clear, and damages are difficult to measure.
many people are involved, causal links are muddy, and damages are easy to measure.
few people are involved, causal links are clear, and damages are easy to measure. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

17. Liability Law… Suppose firm is liable for pollution damages$
MAC1
MD1 d b c
Emissions E* E0
Suppose firm is liable for pollution damages
At E0: TD = b + c + d
Reducing emissions reduces Damage Liability (saves “c+d”)
Reducing emissions increases Abatement Costs (costs “c”)
Threat of lawsuit could encourage optimal emissions

18. Common Law Legal Doctrines Burden of Proof? Standard of Proof?
Strict Liability
Liable for damages regardless the circumstances
Negligence
Liable only if appropriate precautions are not taken
Burden of Proof?
Burden is on victims
Statute of limitations
Standard of Proof?
Direct causal link must be established
Difficult given the probabilistic nature of many exposures

19. Examples Best Case Scenario for Common Law Smoking “causes” cancer?
Exxon Valdez “caused” shoreline damages?
Particular power plant “caused” SO2 damages?
Best Case Scenario for Common Law
Few people involved, causal link is clear, damages easily measured

20. Under a system of negligent liability, a firm disposing hazardous materials into a river would:
be liable for any damages regardless of the circumstances.
be liable for any damages only if the firm did not take reasonable steps to avoid damage.
not be liable for any damages.
none of the above. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

21. Statutory Law Legislative enacted laws Example: #4 from Problem Set
Tax-financed victim’s fund (Netherlands)
Law for the Compensation of Pollution-Related Health Injury (Japan)
CERCLA (US)
Example: #4 from Problem Set

22. In March a small dump truck overturned in Marietta, Ohio, littering the street with cow parts. A smaller shipment fell off of a truck on the same street the following week, running the total of cow-parts spills to four within a year. Said City Councilwoman Katie McGlynn, "I would just like to know why this continues to happen. Maybe we need a stronger ordinance to make this a more serious crime."
[Marietta Times, July 1993]
4. Accidents with trucks carrying cow renderings are fairly common in Marietta. Suppose regulators enact a rule requiring that the perpetrators of such an accident be liable for a sum equal to the average damages of all such accidents in the industry. Would this lead trucking companies to take the socially efficient amount of precaution against such accidents? Explain.

23. 1991 Nobel Prize in Economics
Property Rights
Coase Theorem
If property rights are well-defined and transactions costs low, then private bargaining will lead to an efficient allocation of resources
Corollary: efficient allocation does not depend on initial allocation of property rights
Conditions
“well-defined” property rights
low transactions costs
complete markets
Ronald Coase
1991 Nobel Prize in Economics

24. A factory's production process creates sludge which pours into a river
A factory's production process creates sludge which pours into a river. This sludge makes it difficult to fish in the river, increasing the costs of the local fishermen by $ The factory can install a water filter system for $4500, and the fishermen can utilize a weighted fishing net system (to get under the sludge) for $ Both systems would remedy the sludge damage to the fishermen.
a) Suppose transactions costs are zero. If the factory is not liable and can continue to produce sludge, what outcome do you predict and why?
b) Suppose transactions costs are zero. If the factory is assigned liability for sludge damage, what outcome do you predict and why?
c) Now suppose transactions costs preclude the possibility of private bargaining between the factory and fishermen. If a pollution tax is levied on the factory with the proceeds given to the fishermen, then what outcome do you predict and why?
d) How do your answers to parts (a), (b), and (c) change if the cost of the water filter system was $3500?
e) Discuss the results of parts (a), (b), (c), and (d) in terms of the Coase Theorem.

25. Voluntary Action
Moral suasion
Informal community pressure

26. Command and Control Policies
Mandate behavior coupled with enforcement
Examples
Speed limits
Minimum age restrictions
Minimum wage
Why are standards popular?
Simple and direct
Moral appeal

27. Ambient Standards
Never exceed level of a pollutant in ambient environment
DO can not fall below 3ppm
Expressed in terms of average concentration over time
SO2: μg/m3 annual; μg/m3 daily
Can’t be enforced directly; must monitor emissions that lead to AQ levels

28. Emissions  Environment  AQ
Emission Standards
Never exceed levels applied directly to quantities of emissions
Expressed in terms of quantity per time
Tons per week
Grams per hour
Emissions  Environment  AQ
Meteorlogical
Hydrological
Human decisions

29. Technology Standards Mandated technologies, techniques, and practices
Examples
seat belts
catalytic converters
Scrubbers/baghouses

30. Number of Snowmobiles Allowed (vehicles/day)
Emission Standards Applicable to New Snowmobiles
Carbon Monoxide
g/kw-hr
Hydrocarbons
2005
397
150
2006/2007
275
100
2010 75
2012
200
Yellowstone 2005
120 15
Yellowstone Entry Standards
Number of Snowmobiles Allowed (vehicles/day)
Clinton 2003
Bush
720
Noise Standards for Yellowstone
Decibels
Yellowstone
73 db
Elsewhere
None

31. Economics of Standards
Setting the standard
Should EPA consider damages and abatement costs?
Zero-Risk?
Reasonably small level?
Efficient level?
 tradeoffs made by using avg. concentration levels over time $
MAC MD
Emissions Et E1 E* E0

32. Uniformity of Standards
Geographic differences: MDu > MDr
Single standard can’t be efficient
 tradeoff: regulatory costs vs efficiency gains $
MDu
MAC
MDr
Emissions Eu Er E0

33. Incentives for Improvements
Technology Standards: no incentive
All or nothing!
Emission Standards: some incentive
Polluters seek to reduce abatement costs
Remember: pollution control R&D carried out by pollution-control industry rather than polluting industries themselves

34. If E1 is the standard, then the incentive for R&D = a “cost savings” $
MAC1 MD
MAC2 e d a c b
Emissions E2 E1 E0
With MAC1: cost at E1 = a + b
If E1 is the standard, then the incentive
for R&D = a “cost savings”
With MAC2: cost at E1 = b
If standard is changed to E2 as new technology is adopted, then incentive
to innovate is (a – c)
Technology Forcing: If standard is set at E2 from the start then incentive to
Innovate is (a + d + e)

35. Input Standards or Output Standards?
Total
Emissions =
Total Output X
Inputs used per unit of output
Emissions per unit of input
E = [Q] x [Inputs/Q] x [E/Inputs]
Auto Emissions = [# Vehicles] x [Miles/Vehicle] x [Emissions/Mile]
Emission Standards
“end of tail pipe”

36. Economics of Enforcement
Monitoring & Sanctioning Costs
MPC = Marginal Penalty Curve = P x F x E
With MPC1, firm only cuts back to E1
To get to E*, must raise MPC1 to MPC*
Raise P
Raise F
P = probability of detection
F = monetary fine
E = emissions $
MAC
P = 0.25
F = $100/E
E = 10,000
MPC = (.25)(100)(10,000)
= $250,000
MPC*
MPC1
Emissions E* E1 E0

37. How do Standards Hold Up?
Efficiency
Cost Effectiveness
Fairness
Incentives for Technological Improvements
Enforceability
Morality

38. Incentive-Based Strategies
Emission Taxes
Emission Subsidies

39. Emission Taxes Pigouvian taxes
Government sets tax = $t per unit of emissions
Polluter has incentive to reduce emissions until MAC = t
Standard at E1 would only cost firm area "b"; much less than the tax $
MAC
Tax bill t
Abatement Cost b
Emissions E1 E0

40. [Tax revenues are not included in social cost calculation]
Optimal Tax
Optimal t* occurs where MD = MAC MD
Reduced damages = e + f
MAC
Remaining damages = b + d
Tax cost = a + b + c + d f t*
[Tax revenues are not included
in social cost calculation] c a d e b
Two-part tax?
Allow E1 emissions free E1 E* E0
Apply t* to anything above E1
Tax payment = c + d
If MD is unknown, use iterative process:
If AQ doesn’t improve  raise t
If AQ improves too much  lower t

41. Suppose that society's marginal abatement cost function is given by MAC = E and society's marginal damage function is given by MD = 3E. What is the optimal level of pollution emissions? 50 30 20 10 5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

42. According to the situation above, what would be the optimal per unit pollution tax?
$50
$40
$30
$20
$10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

43. Efficiency Uniform Emissions Non-Uniform Emissions Firm A Firm B
Equimarginal principle is satisfied
efficiency results possible even though agencies may know nothing about MAC at sources (unlike standards, where agencies must know MAC)
Non-Uniform Emissions
single tax not fully efficient: deals with differences in MAC, but not differences in MD
1 unit reduction by Firm B is better than 1 unit reduction by Firm A
Firm A
Firm B

44. Zoned Taxes?
Warning: reducing emissions through one medium may increase emissions elsewhere

45. Incentive to Innovate MAC1 MAC2 t* c d a b e E2 E1 E0 With tax t*:
MAC1: Cost = (d + e) + (a + b + c)
MAC2: Cost = (b + e) + (a)
Recall: cost savings for standard
at E1 was only d.
Cost savings = c + d

46. Enforcement and Examples
Enforcement costs
Higher monitoring requirements compared to standards
Non-point sources are difficult to monitor/tax
Revenues give regulators incentive to monitor
Examples
CO2 taxes: Scandinavia
State emission fees for criteria pollutants

47. South Coast AQMD For emissions in Calendar Year 2008
Annual Emissions (tons/yr)
Organic Gases ($/ton)
Specific Organics ($/ton)
Nitrogen Oxides ($/ton)
Sulfur Oxides ($/ton)
Carbon Monoxide ($/ton)
Particulate Matter ($/ton)
4 – 25
$517.08
$92.52
$302.52
$358.65 --
$395.41
> 25 – 75
$839.53
$146.58
$480.53
$579.77
$640.70
> 75
$1,
$219.87
$723.70
$870.45
$959.28
> 100
$6.18
Source: South Coast AQMD, Rule 301, Table III. Available at

48. Enforcement and Examples
Enforcement costs
Higher monitoring requirements compared to standards
Non-point sources are difficult to monitor/tax
Revenues give regulators incentive to monitor
Examples
CO2 taxes: Scandinavia
State emission fees for criteria pollutants
tax on cars to control auto emissions
total emissions per year = (E/mile) x (# miles per year)
Gasoline taxes

49. Federal tax is 18.4 cents per gallon
Source:

51. Tax the input, rather than output
More examples…
Non-point sources
Agricultural runoff
pesticides
fertilizer
Distortions?
Trash stickers
pack more garbage into each bag
tax on house windows
Tax the input, rather than output

52. Distributional Concerns
Regulatory costs may be passed on
to consumers through higher prices
to workers through reduced employment (and lower wages) S2 $ S1 P2 P1 D1
Quantity Q2 Q1

53. Subsidies Types Examples: technology subsidies abatement subsidies
while emissions per firm may go down, new firms may be attracted to the industry!
Examples:
deposit refund systems:
Cars
Batteries
Bottles/cans
Tax credits
5¢: CA, CT, DE, HI, IA, ME, MA, NY, OR, VT
10¢: MI

54. Current Models Make Model Estimated Tax Credit Chevrolet Malibu Hybrid
$1,300
Tahoe Hybrid
$2,200
Ford
Escape Hybrid (2wd)
$3,000
Escape Hybrid (4wd)
GMC
Yukon Hybrid
Honda
Civic Hybrid (auto)
$2,100
Lexus
RX 400h
GS 450h
$1,550
Mercedes
GL 320 Bluetec (clean diesel)
$1,800
Mercury
Mariner Hybrid (2wd)
Nissan
Altima
$2,350
 Saturn
Vue Green Line
$ 650
Saturn
Aura Green Line
Toyota
Camry Hybrid
$2,600
Highlander Hybrid
Prius
$3,150
Volkswagen
Jetta TDI (clean diesel)

55. Pollution Worksheet Marietta-Parkersburg area emissions:
Current emissions = 90,000 units
Optimal emissions = 60,000 units
Marginal Abatement Cost
Cars: $5
Utilities: $10
Factories: $20
Controlling pollution through:
Standards
Taxes
Tradable Permits

56. Standards Set a maximum emissions of 20,000 units per source: 20,000
ABATED
ABATEMENT
COSTS
CARS
UTILITIES
FACTORIES
TOTAL
20,000
20,000
10,000
$100,000
20,000
20,000
$400,000
60,000
30,000
$500,000

57. Standards Require each source to cut emissions by 10,000 units: 10,000
ABATED
ABATEMENT
COSTS
CARS
UTILITIES
FACTORIES
TOTAL
10,000
10,000
$50,000
20,000
10,000
$100,000
30,000
10,000
$200,000
60,000
30,000
$350,000

58. Standards Require each source to cut emissions by 1/3: 13,333 6,667
ABATED
ABATEMENT
COSTS
CARS
UTILITIES
FACTORIES
TOTAL
13,333
6,667
$ 33,335
20,000
10,000
$100,000
26,667
13,333
$266,660
60,000
30,000
$399,995

59. Standards “$200,000 Solution”
Cost-minimizing strategy of reducing emissions by 60,000 units.
SOURCE
EMISSIONS
ABATED
ABATEMENT
COSTS
CARS
UTILITIES
FACTORIES
TOTAL
20,000
$100,000
20,000
10,000
$100,000
40,000
60,000
30,000
$200,000
“$200,000 Solution”

60. Taxes A tax of t = $6 per unit of pollution is imposed: 20,000
SOURCE
EMISSIONS
ABATED
ABATEMENT
COSTS
TAX COSTS
CARS
UTILITIES
FACTORIES
TOTAL
20,000
$100,000
30,000
$180,000
40,000
$240,000
70,000
20,000
$100,000
$420,000

61. Taxes A tax of t = $11 per unit of pollution is imposed: 20,000
SOURCE
EMISSIONS
ABATED
ABATEMENT
COSTS
TAX COSTS
CARS
UTILITIES
FACTORIES
TOTAL
20,000
$100,000
30,000
$300,000
40,000
$440,000
40,000
50,000
$400,000
$440,000

62. Tradable Permits S “$200,000 Solution” D $ F U Auction Revenue C = MAC
Abatement Cost U
$10
P = $10
Q = 60,000
Auction
Revenue C $5 D
= MAC 40 60 70 90
permits
“$200,000 Solution”

63. Tradable Discharge Permits
TDPs rely on decentralized cooperation
Central authority sets aggregate # permits (CAP)
Each polluter is allocated certain number of emission permits
Each permit allows 1 ton of SO2
Polluter must then make a choice:
Reduce emissions to level covered by allocated permits
Reduce emissions below original permit level, then sell excess permits
Buy additional permits (to enable expanded production)

64. Permit Market Buyers Sellers New firms
Existing firms looking to expand
Sellers
Firms leaving area/industry
Those who’ve invested in efficient technology $ S P* D Q*
Permits
Permits flow from low MAC polluters to high MAC polluters so as to satisfy equimarginal principle
2008 Spot Auction
yr Advance Auction

66. Trading Rules Should be simple and clear to minimize uncertainty
Initial Permit Allocation?
Equal allocation?
Ignores differences in firm size
According to existing emissions?
Ignores that some firms have already cut emissions
Give away or auction?
Coase Theorem

67. Trading Rules… Who may participate? How will trades take place?
Local, regional, national, international polluters?
Environmental groups?
Speculators?
How will trades take place?
Sealed bids for annual EPA auction
Brokers are used for secondary markets
Do regulators have veto power?

68. Potential Problems Market power Thin markets Permit life span
Hot spots (non-uniform emissions)
Tradeoff: competitive markets vs. enviro damage
Urban Area
“transfer coefficient” B C A D
Prevailing
Wind

69. Enforcement EPA must monitor:
Number of permits in possession of each polluter
CBOT
Quantity of emissions from each source
Incentive for polluters to monitor each other to prevent cheating (reduces demand for permits)

70. Incentives for Innovation$
Permit price = $50
$200
MAC1
MAC1 = E1
MAC2 = 100 – E2
MAC2
$100
$50 c d a b e
TAC with MAC1 = d + e = $625 50 75
100
emissions
TAC with MAC2 = b + e = $1250
Revenue from TDP = b + c = $1250
Cost Savings =
(d+e) – (b+e) + (b+c) = d + c = $625
Cost savings as good as emission taxes

71. Which of the following is a criterion for evaluating environmental policies?
efficiency
fairness
incentives to improvements
enforceability
All of the above

72. Private bargaining can lead people to the efficient outcome if
transactions costs are low and property rights are well defined
transactions costs are high and property rights are ill defined
transactions costs are high and property rights are well defined
transactions costs are low and property rights are ill defined

73. The two defining features of command-and-control regulation are
cost-effectiveness and flexible standards
pollution taxes and marketable permits
uniform standards and technology-based regulations
monitoring and compliance

74. Emission taxes are generally regarded as efficient since
they raise the maximum amount of revenue possible for the IRS
they encourage all pollution sources to completely eliminate their emissions
they require environmental regulators to know the individual source marginal abatement
they encourage all pollution sources to adjust their emissions so that the equimarginal principle is satisfied.

75. Emission taxes are more likely to be effective when applied to
nonpoint sources of pollution
point sources of pollution

76. Marketable pollution permits require a slightly more complex system when there are geographic differences in pollution effects. One possible approach to designing a system of permits would be to:
use technology-based standards in conjunction with the permits
auction off the permits one-by-one over time until all permits have been allocated
simply give the permits away to polluters based on their historic emissions rate
establish separate markets for each subregion