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?

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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

MC2MC1

T

QtpPollution Control (tons)

Q1 0 15

Q2 15 0

Pollution abated by polluter 1 Pollution abated by polluter 2

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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

$

PollutionAbatedQ Q'

MC

MC'

Case 1: Tax

9

T

$

PollutionAbatedQ Q'

MC

MC'

Case 1: Tax

Savings from Tech change

10

T

$

QQ Q’

MC

MC'

Case 1: Tax

11

$

Pollution AbatementQTP

MC

MC'

Case 2: tradeable permit

12

$

QQTP

MC

MC'

Case 2: tradeable permit

13

$

QQTP

MC

MC'

Plus cost savings from cheaper permits

Case 2: tradeable permit

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Technology change cont’d

Change in pollution

Private gains

Pollution Tax Pollution will decrease

Reduced MC + avoided tax

Tradable Permit No change Reduced MC + cheaper permits

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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?

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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)

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Example 1MCE

MB

Q

$

19

Example 1MCE

MB

Q

$

MC R

20

Example 1MCE

MB

Q

$

MC R

T

Q* QtaxQTP

21

Example 1MCE

MB

Q

$

MC R

T

Q* QtaxQTP

DWL for tax

DWL for TP

22

Example 2

MCE

MB

Q

$

23

Example 2

MCE

MB

Q

$

MCR

24

Example 2

MCE

MB

Q

$

MCR

T

Q*Qtax QTP

25

Example 2

MCE

MB

Q

$

MCR

T

Q*Qtax QTP

DWLtax

DWL TP

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Benefit Uncertainty

MC

MBE

Q

$

MBR

T

QTp

QT

Q*

DWL TP = DWL Tax

27

Simultaneous benefit and cost uncertainty

MCE

MBE

MBR

T

QTp QT Q*

MCR

DWL TP

DWL Tax

Q

$