environmental economics

Chapter 13

2 issues

what is appropriate level of waste? how to achieve that level (who has to reduce

how much?)

take usual approach

identify efficient levels of pollution discuss market levels of pollution demonstrate how policy can reconcile

pollutant taxonomy

stock pollutants: accumulate over time / little or no absorptive capacity

– nondegradable materials– heavy metals

fund pollutants: some capacity to be absorbed– organic pollutants– CO2

efficient allocation depends on nature of pollutant

fund pollutants: efficient allocation

if no accumulation, future damage independent of current emissions…can use static framework

max net benefit from pollution– minimize costs: 2 types

damage costs (increasing in pollution) control / avoidance / abatement costs (decreasing in pollution)

efficient allocation of a fund pollutant

efficiency: MCC = MDC

points left of Q* (less pollution) inefficient– cost > benefit in damages avoided

points right of Q* (more pollution) inefficient– damages > cost of cleanup

increasing or decreasing control would increase TC

optimal pollution not zero

cases where could be very close to zero MDC of first unit > first unit MCC (plutonium?)

MCC

MDC

pollution

$

market allocation of pollution

damage costs externalities; control costs not– cheap to a firm not cheap to society

problem particularly severe with stock pollutants– extra burden on future generations due to

accumulation

policy responses

how to achieve MCC = MDC?

legal limits (Q*) internalize damage through tax / charge

system

easy in theory / difficult in practice

need to know Q where 2 MC’s cross for every emitter (high information costs)

alternative: select Q based on other criteria– safe for human / ecological health

then, how to allocate responsibility for meeting this level?

use cost-effectiveness criterion– not necessarily optimal, but minimizes cost given some

level Q

cost-effective allocation: example

assume 2 sources currently emitting 30 units

reduce to 15 units

how to allocate reduction between 2 sources?

cost-effective reductions

cost-effective reductions

source 1 cleans up 10 units (cost A) source 2 cleans up 5 units (cost B)

any other allocation…higher TC (area bigger)

demonstrates important proposition

cost of achieving given reduction in emissions will be minimized if and only if MC of control (abatement) equal across emitters

what policy instrument to achieve equality?– emissions standards– emissions charges– emissions trading

emissions standards

command and control

equal reduction?

not cost-effective

first source lower cost

total costs increase if both forced to clean up same

emission charges

fee on each unit emitted

profit-maximizing firm controls rather than emits when cheaper to do so

cost-minimizing control of pollution with an emission charge

emission charges

if no pollution control, pay OTBC

best can do?

no: cheaper to pay to reduce emissions until MC reduction = emissions charge

minimizes cost by cleaning up 10 units and emitting 5 units

pay OAD in control, ABCD in emission charges, total costs OABC < OTBC

emission charges

if levied same charge on both, each source would control until MC = charge, and independently choose levels of control consistent with equal MC costs

as long as authority imposes same charges, automatically minimize TC of control– despite lack of information on firm’s costs

how to SET appropriate emissions charge?

iterative trial and error choose rate, observe reduction

– if too large, reduce– if too small, increase

charges not only create cost-effective allocation, also stimulates technological progress

cost savings from technological change: charges versus standards

charges vs. standards

standard based on specific technology

as new technology discovered, standards tightened

firms have incentive to HIDE technological advances

with charges system, firm saves $ (A+B) if can reduce pollution at MC < T

voluntarily reduces emissions from Q0 to Q1

Q

transferable emission permits

can identify cost-min allocation without trial and error

all sources required to have permits to emit

freely transferable

authority issues exactly # permits needed to produce desired emission level

emissions permit system

emissions permit system

suppose source 1 has 7 permits (1 permit = 1 emission unit)

– controls 8 units

suppose source 2 has 8 permits – controls 7 units

both firms have incentive to trade (MC2>MC1)

emissions permit system

source 2 can lower cost by buying permit from source 1 at price < C

source 1 better off selling permit at price > A

transfer until – source 1 has 5 permits (controlling 10) – source 2 has 10 permits (controlling 5)

permit price = B– neither source had incentive to trade further

other issues with instruments

revenue effect– taxes / charge system raises revenue; permits do

not– may be “double dividend”…use revenue to offset

other taxes

another issue: uncertainty

cost of being wrong

MDC

MCC

MCC

MDC

emissions controlledemissions controlled

$ $

use permits

use charges

Prevent large fluctuations in damage costs Prevent large fluctuations in control costs