1 Pollution Control

2 Outline Topics from lecture: Overview Problem (the problem from section is posted in the handout section of the course website and includes most of the steps) Technology change Uncertainty

3 Overview Economic efficiency criterion —> benefit-cost analysis –MC=MB (Prior to Midterm) More modest criterion: cost- effectiveness — does policy accomplish given purpose in the least costly way? –MC1=MC2

4 More Criteria for Selecting Environmental Policy Instrument 1. Achieve stated goals/standards? 2. Cost-effective? 3. Provide government with information it needs? 4. Monitoring and enforcement possibilities? 5. Flexible in the face of change (in tastes, technology, or resource use)? 6. Dynamic incentives for research, development, adoption, and diffusion of better pollution-control technologies? 7. Equitable distribution of financial and environmental impacts? 8. Purpose and nature of policy understandable to general public? 9. Feasible, in terms of enactment and implementation?

5 Topic 1: Technology Change Two questions of interest: 1.What incentives does the policy give firms to adopt new technologies? 2.What incentives does the policy instrument provide to induce invention and innovation?

6 Cost-Effective Pollution Control Allocations MC $/ton MC2 MC1 T Qtp Pollution Control (tons) Q1015 Q Pollution abated by polluter 1 Pollution abated by polluter 2

7 Answer to both questions is… it depends on how much polluting firms gain from the new technology. This has three components 1.Reduction in marginal abatement costs; and 2.Avoided tax payments; or 3.Reductions in equilibrium permit price.

8 T $ Pollution Abated Q Q' MC MC' Case 1: Tax

9 T $ Pollution Abated Q Q' MC MC' Case 1: Tax Savings from Tech change

10 T $ Q Q Q’ MC MC' Case 1: Tax

11 $ Pollution Abatement Q TP MC MC' Case 2: tradeable permit

12 $ Q Q TP MC MC' Case 2: tradeable permit

13 $ Q Q TP MC MC' Plus cost savings from cheaper permits Case 2: tradeable permit

14 Technology change cont’d Change in pollution Private gains Pollution TaxPollution will decrease Reduced MC + avoided tax Tradable PermitNo changeReduced MC + cheaper permits

15 Technology change: bottom line Q of pollution will decrease in response to tech change under tax and remain fixed under TP. Incentives for adoption and innovation depend on case-specific factors (avoided tax, savings from cheaper permits, and related factors).

16 Uncertainty What are likely sources of uncertainty about costs and benefits? Why is there an asymmetry between uncertainty re. costs and uncertainty re. benefits?

17 Conceptually, the slopes measure the cost of being wrong. If the slope of MB is relatively large, then we want to lock in the quantity of pollutant (environmental damages are very large if we’re wrong) If the slope of MC is relatively large, then we want to give firms flexibility (compliance is very costly if we’re wrong)

18 Example 1 MC E MB Q $

19 Example 1 MC E MB Q $ MC R

20 Example 1 MC E MB Q $ MC R T Q*Q* Q tax Q TP

21 Example 1 MC E MB Q $ MC R T Q*Q* Q tax Q TP DWL for tax DWL for TP

22 Example 2 MC E MB Q $

23 Example 2 MC E MB Q $ MC R

24 Example 2 MC E MB Q $ MC R T Q*Q* Q tax Q TP

25 Example 2 MC E MB Q $ MC R T Q*Q* Q tax Q TP DWL tax DWL TP

26 Benefit Uncertainty MC MB E Q $ MB R T Q Tp QTQT Q* DWL TP = DWL Tax

27 Simultaneous benefit and cost uncertainty MC E MB E MB R T Q Tp QTQT Q* MC R DWL TP DWL Tax Q $