1. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 13 Economics of Pollution Control: An Overview

2. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-2 Why Is There Pollution? Pollution is a by-product of the production process  Treated as a zero-priced input Dispose of waste for free  Otherwise have to purchase abatement equipment Since price = 0 => consume to the point: MV = 0  However MC ≠ 0 So have a deadweight loss due to MV < MC

3. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-3 Negative Externality Marginal Private Costs < Marginal Social Costs Ideal Actual Pa Pi

4. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-4 Economics and Pollution Control The Two Big Questions 1.What is the optimal level of pollution? 2.How should it be allocated among its sources (firms)?

5. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-5 A Pollutant Taxonomy The ability of the environment to absorb pollutants is called its absorptive capacity. Stock pollutants are pollutants for which the environment has little or no absorptive capacity. Fund pollutants are pollutants for which the environment has some absorptive capacity. Local pollutants cause damage near the source of emissions while regional pollutants cause damage at greater distances.

6. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-6 For Today Focus on  Fund pollutants Emission rate is low enough to be absorbed by the environment  No consequences for future generation Need only address static efficiency  Don’t need 2-period model (yet)  Local pollutant Effects are mostly contained within the local environment  E.g., I-5 corridor (Puget Sound air basin)

7. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-7 What Do We Need for Efficiency? Economic efficiency requires  Minimize the costs of 1.Damages caused by pollution 2.Costs of reducing pollution  At the margin (or at the optimum) Marginal (additional) costs of reducing pollution (pollution abatement costs) = marginal damages caused by incremental change in emissions  Alternatively Maximize the benefits (derived from goods produced) While minimizing abatement and damage costs Yields same solution

8. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-8 What Do We Know About the Costs of Reducing Pollution? Costs of reducing  Additional costs of reducing pollution will be greater when level of pollution is higher  Titenberg’s example First electrostatic precipitator reduces emissions by 80% Second (added) EP by another 80%  Effectively 80% x 20% (remaining) = 16% Third EP  80% x 4% = 3%

9. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-9 What Does the Cost Curve Look Like?

10. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-10 How About the Costs of Damages Similarly  Marginal (additional) damage increases with an increase in the total amount of pollution

11. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-11 Determining the Optimal Amount of Pollution

12. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-12 Optimal Level of Pollution Occurs where  Marginal damage costs = marginal abatement costs Some simplifications that we’ve made  Optimum can vary Each firm will have different abatement costs Not all geographic area have same damage costs  More densely populated areas likely to have higher damage costs  Differences in absorbing capacity of different geographic areas

13. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-13 How Do We Get There? Standards (command and control)  Set the overall standard at Q*  Calculate the amount of reduction necessary  Set uniform reduction goal for all firms Taxes/Emission Charges  Set the tax = externality cost at the optimum Q*  Firms will internalize the cost Tradable Permits (Coase)  Allocate right to pollute (Q*/N)  Allow firms to set price for trading permits

14. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-14 Cost-Effective Pollution Control Policies Emission Standards  An emission standard is a legal limit on the amount of the pollutant an individual source is allowed to emit.  This approach is referred to as command-and- control.

15. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-15 Emissions charges  An emission charge is a per-unit of pollutant fee, collected by the government.  Charges are economic incentives.  Each firm will independently reduce emissions until its marginal control cost equals the emission charge. This yields a cost-effective allocation  A difficulty with this approach is determining how high the charge should be set in order to ensure that the resulting emission reduction is at the desired level.

16. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-16 FIGURE 15.4 Cost-Minimizing Control of Pollution with an Emission Charge

17. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-17 FIGURE 15.5 Cost Savings from Technological Change: Charges versus Standards

18. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-18 Emissions Trading All sources are allocated allowances to emit either on the basis of some criterion or by auctioning. The allowances are freely transferable. The equilibrium price will be the price at which the marginal control costs are equal for both (or across all) firms. The market equilibrium for an emission allowance system is the cost-effective allocation.

19. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-19 FIGURE 15.6 Cost-Effectiveness and the Emission Permit System

20. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 15-20 FIGURE 15.3 Cost-Effective Allocation of a Uniformly Mixed Pollutant