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

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
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

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

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

5. What Do We Need for Efficiency?
Economic efficiency requires
Minimize the costs of
Damages caused by pollution
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
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

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

7. 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
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

8. 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
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

9. 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.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

10. 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.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

11. FIGURE 15.4 Cost-Minimizing Control of Pollution with an Emission Charge
Tax = mc of control
Tax
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

12. FIGURE 15.5 Cost Savings from Technological Change: Charges versus Standards
Both firms reduce to the same level
But have different mcosts
Using tax
Get less emissions
standard
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

13. 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.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

14. FIGURE 15.6 Cost-Effectiveness and the Emission Permit System
Standard
MC of emitting 8
Bid range
Tax
MC of emitting 7
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

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

16. Comparison of Approaches
Standards
Can also produce optimal level of pollution
But set same standard for all firms (and are not productively efficient, e.g. min cost)
To set individual quotas: requires knowledge of each firm’s costs
But have higher administrative costs
Not only have to monitor emissions
Enforcement costs: legal proceedings (time delays and expense)
Not very flexible: regulatory process for changing standards
Provide no incentive for firms to reduce pollution below current “authorized” levels
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

17. Comparison of Approaches
Standards
Are most useful when:
Problem is short-lived (“burn” bans for high pollution days)
Optimal level is zero
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

18. Comparison of Approaches
Taxes
Can produce “optimal” amount of pollution at minimum costs and lower administrative costs
Kneese (1977): comparing taxes versus standards found that desired quality costs half as much using taxes
Automatically allocates pollution levels among firms based on their costs
Provides incentive for firms to reduce pollution levels through technological innovation
Easy to adjust/”tune”
Tax revenues can be used finance admin costs
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

19. Comparison of Approaches
Tradable Permits
Cost efficient
Firms will purchase permits from more efficient firms if permit cost < abatement (technology) costs
Technological incentive to reduce pollution
Marginal cost of abatement = permit cost
Similar to taxes
Administratively simpler
Require less information about the firms’ cost
Better able to handle “spatial” variation in pollution
Fewer permits auctioned in bad areas
Adjust “automatically” for changes in inflation and growth
If auctioned -> revenues for admin costs or for “buyback” programs
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.