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

Externalities An externality is a cost or benefit associated with a transaction not borne by the decision maker –Full benefits and/or full costs not included in market price –Pollution External cost –Education External benefit 2

Optimal Level with negative externality External costs with fixed technology –Marginal social cost Marginal private cost Marginal external cost –Set MSC = MSB Optimal Q* & P* –Set MC = MB Too much produced at too low a price 3

Positive Externalities Education –Personal benefits –Benefits to society Set MSC = MSB –Optimal Q* and P* MC = MB –Too little consumed at too low a price Public policy –To increase quantity beyond private optimum 4

Optimal Level with negative externality To achieve socially efficient production –Demand (marginal benefit) intersects marginal social cost curve –Government regulation Limit production Tax = marginal external cost 5

Optimal Level with positive externality To achieve socially efficient production –Demand (marginal benefit) intersects marginal social cost curve –Government regulation Subsidy = marginal external benefit –Subsidize consumers –Subsidize producers 6

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 –As air becomes cleaner it is harder to make cleaner still 7

Optimal Level of Pollution Reducing greenhouse gases –Marginal social cost curve Marginal cost of enduring pollution Upward-sloping –Marginal social benefit curve Marginal cost of reducing pollution Downward-sloping –Optimal level of air quality Marginal social benefit = marginal social cost 8

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 9

Criticisms of Economic Analysis Measurement problems –Cost of enduring pollution Not all costs are easily quantified –Cost of removing pollution Technological –More easily quantified Who has the right to clean environment? –World does not run by economic trade- offs alone 10

Optimal Level of Pollution The Coase theorem –Problems of externalities will be resolved efficiently through private exchange, regardless of the assignment of property rights, so long as there are no transactions costs 11

Optimal Level of Pollution Coase Theorem –Efficient solution Least cost solution Assign property right to one party One side bears the externality cost –Transactions costs arise Scientific and technical uncertainties Legal uncertainties Costs of negotiation 12

How to Achieve Optimal Level of Pollution Command & Control –Engineering controls and pollution ceilings Not efficient Legal system –Tort law Difficulties arise 13

How to Achieve Optimal Level of Pollution Pollution Charges –Efficiency can be achieved –How large is tax? –Polluters have “right” to pollute Market for pollution rights –Government sells pollution rights Limits maximum level of pollution per day –Firms buy and sell pollution permits –Value of pollution permits fluctuates 14

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 15

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 17

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 18

Water Pollution Sources –Sewage –Chemicals Sewage –Dumped into waterways; no cleaning Negative externality –Federal money: treatment plants 19

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 20

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 21

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 22

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 23