Chapter 17 Externalities and the Environment © 2009 South-Western/ Cengage Learning

Renewable Resources Used conservatively – Can be drawn on indefinitely Some are open-access Common-pool problem – People exploit a resource Personal marginal benefit > personal marginal cost – Personal marginal cost Ignores costs imposed on others 2

Renewable Resources Not owned as private property Open-access resources – No private property rights – Negative externalities 3

Resolving the Common-Pool Problem Open-access resources Government regulation – Output restrictions – Taxes – Use resource: socially optimal rate – Improve allocative efficiency 4

Optimal Level of Pollution External costs with fixed technology – Fixed-production technology Cut emissions: cut production – Marginal social cost Marginal private cost Marginal external cost 5

Optimal Level of Pollution Socially efficient production – Demand (marginal benefit) intersects marginal social cost curve – Government regulation Limit production Tax = marginal external cost – Marginal social cost = marginal benefit – Total social gain Total social cost (firms ignore external cost) 6

Exhibit 1 Negative externalities: market for electricity, Midwest $0.14 Dollars per kilowatt-hour Marginal social cost Marginal private cost; 50 million kilowatt-hours of electricity are produced per month. The marginal external cost of production is imposed on society. 350 Millions of kilowatt-hours of electricity per month 50 Marginal private cost D a c Marginal social cost; only 35 millions kilowatts-hour are produced, which is the optimal output. Marginal social cost curve includes marginal private cost and marginal external cost. Total social gain b

Optimal Level of Pollution External costs with variable technology – Variable technology Reduce emissions: alter the production process Cleaner technology – Production of cleaner air Diminishing returns 8

Optimal Level of Pollution Reducing greenhouse gases – Marginal social cost curve Upward-sloping – Marginal social benefit curve Downward-sloping Diminishing marginal benefit to society – Optimal level of air quality Marginal social benefit = marginal social cost – Higher than optimal level of air quality Social waste 9

Exhibit 2 The optimal reduction in greenhouse gas emissions 10 Dollars per unit Total social gain Marginal social cost Marginal social benefit AHigh Greenhouse gas emissions A’Low a b c Optimal level of greenhouse gas emissions: point a; marginal social benefit of reducing such emissions = the marginal social cost If some lower level of emissions were dictated by the government, the marginal social cost would exceed the marginal social benefit, and social waste would result.

Optimal Level of Pollution Shift in marginal social cost curve – Technological breakthrough: Lower marginal cost of cutting greenhouse gas Downward shift of MSC curve Lower optimal level of emissions Shift in marginal social benefit curve – Higher marginal benefit of reducing emissions Upward shift of MSB curve Lower optimal level of emissions 11

Exhibit 3 Effect of changes in costs or benefits of reducing greenhouse gas emissions 12 Marginal social benefit Marginal social cost Dollars per unit A 0 A’ Higher quality air Marginal social benefit Marginal social cost Dollars per unit A 0 A’’ Higher quality air MSC’ (a) Lower cost of reducing emissions(b) Greater benefit of reducing emissions MSB’

The lungs of the planet Tropical rainforests = open-access – Recycle carbon dioxide: oxygen and wood 6-7% of Earth’s land surface Half of world’s plant and animal species – In relatively poor countries Burn forest – Pasture – Farmland – Growing demand for timber 13

The lungs of the planet ‘Slash and burn’ – Add greenhouse gas to atmosphere – Reduces atmosphere’s ability to clean itself – Flash floods – Mud slides – Soil erosion, lost nutrients – Lost ecosystem 14

The lungs of the planet Tropical rainforest – Benefits around the globe – Little immediate personal cost – Costs of deforestation: around the globe Solution – Property rights 15

Optimal Level of Pollution The Coase theorem – For low transaction costs – Efficient solution Least cost solution Assign property right to one party One side bears the externality cost – Inefficient outcome If high transaction cost If large number of parties involved 16

Optimal Level of Pollution Market for pollution rights – Government Sells pollution rights Limits maximum level of pollution per day – Firms D = marginal value of pollution Buy pollution rights – Value of pollution permits Fluctuates 17

Exhibit 4 Optimal allocation of pollution rights Tons of discharge per day Dollars per ton 25 $35 D’ D S Suppose the demand for a river as a discharge service is D. No environmental controls: polluters dump 250 tons per day, where the marginal benefit of discharge is zero. Regulatory authorities: establish 100 tons as the maximum daily level of discharge and then sell the rights, the market for these pollution rights clears at $25 per ton. If the demand for pollution rights increases to D’, the market-clearing price of pollution rights rises to $35 per ton.

Pollution Rights and Public Choice Pollution regulation – Special interest of polluters Before 1990 – Command-and-control environmental regulations Particular technologies to reduce emissions Market for pollution rights – Economic efficiency approach Reduce emissions: Cost-effective 19

Environmental Protection Environmental Protection Agency EPA Clean air act of 1970 Clean water act of 1972 Resource conservation and recovery act of 1976 Superfund law of

Air Pollution Atmosphere – Economic resource – People value clean air; willing to pay more Smog – 40% from automobile emissions – 40% from consumer products – 15% from manufacturing 21

Air Pollution Clean air act of 1970 – 90% reduction in auto emissions – By 1990, average emissions fell Lead: 97% Monoxide: 41% Sulfur dioxide: 25% U.S. air quality: good U.S. – major source of fossil-fuel carbon dioxide emissions 22

Exhibit 5 (The 25 worst nation) Fossil-fuel carbon dioxide emissions per capita 23

Makesicko city Mexico City – Population increase From 3 million in 1950 To 20 million today – More industry; More vehicles – High pollution; Low oxygen, Tropical sun – Average commuting time: 4 hours/day – Low incomes Environmental quality = luxury 24

Water Pollution Sources – Sewage – Chemicals Sewage – Dumped into waterways; no cleaning Negative externality – Federal money: treatment plants 25

Water Pollution Chemicals – 10% from point pollution Factories, industrial sites – Two thirds – from nonpoint pollution Agricultural pesticides and fertilizers – In most states: pesticides have fouled some groundwater 26

Hazardous Waste and the Superfund Before 1980 – Firms Pay others to haul and dispose Not responsible for cleaning Superfund law of 1980 – Companies Pay others to haul and dispose Pay for clean up 27

Solid Waste:”Paper or Plastic?” U.S. households – 4 pounds of garbage per resident per day Mostly packaging – 200 million tons per year 70% of garbage - landfills Recycled: 15% of garbage – 75% paper products 15% - incinerated – Trash-to-energy plants 28

Exhibit 6 Paper and cardboard recycling: top 25 among advanced economies 29

Solid Waste:”Paper or Plastic?” 2 out of 3 aluminum cans: recycled Returnable deposit laws – Increase recycling Recycling: imposes environmental costs – Curbside recycling Trucks – Newsprint De-inked 30

Positive Externalities Beneficial externalities Education – Personal benefits – Benefits to society Positive externality Public policy – To increase quantity beyond private optimum 31

Exhibit 7 Education and positive externalities 32 E 0 E’ Quantity of education per period Dollars per unit D Marginal private benefit D’ Marginal social benefit S Marginal cost e’ e No government intervention: equilibrium quantity of education (E); marginal private benefit of education equals the marginal cost as reflected by the supply curve. Education also confers a positive externality on the rest of society, so the social benefit exceeds the private benefits. At E, the marginal social benefit exceeds the marginal cost, so more education increases social welfare. In this situation, government tries to increase education to E’, where the marginal social benefit equals the marginal cost.