Regulating externalities

SPHA511, John Ries

Externality-based environmental problems

• A pulp mill's emissions that damages a fishery• air pollution caused by automobile exhaust and

industrial emissions• acid rain caused by coal burning production releasing

SO2• ozone depletion caused by chloroflourocarbons (CFCs)

which chemicals used for refrigeration, foam packaging, and aerosol cans

• global warming due to greenhouse gases (carbon particles from fossil fuel combustion, etc.).

Definition: An externality is a non-priced effect on the welfare of one agent in the economy resulting from the activities of another.

Effects of negative externalities

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quantity

MB

PMC

SMC

QQ*

- activities with negative externalities will be carried out at a level which is too high from a social point of view (and vice versa for positive externalities).

- the socially optimal level of the activity is greater than zero.

externality

Pollution abatement

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abatement

SMB

SMC

Q*

In the previous graph, there is too much of the polluting activity (too many pulp mills, too much driving).

Here, the amount of pollution per unit of activity is being reduced (abated) (e.g., make cars/pulp mills operate more cleanly).

Why do non-priced effects exist?

• Consider a neighbor who plays disturbing loud music. The utility the neighbour gets from the music is $80 and the disutility I get from the noise is $100. In this situation, the efficient solution is to disallow the music. In principle, this can be achieved by negotiation between those affected by the action. In practice this requires:– assignment of property rights.

– low transaction costs

Priced effects on third parties

• If I outbid you for a house, my action has adverse consequences on you. This IS NOT a market failure. In bidding for the house, the price system is at work where each of us is conveying our willingness to pay. Allocational efficiency requires the house go to the person with the highest willingness to pay. Third party effects are “priced” whenever a market is in place that allows people to trade based on preferences and costs. Markets require well defined property rights and low transaction costs.

Policy Solutions

• Solution #1. Internalizing the externality

• Solution #2. Quantity controls or standards

• Solution #3. Taxes

• Solution #4. Assignment of property rights and creation of a market

Illustrating Alternative Approaches

of Pollution Reduction

• Standard = 5000 ppm • Tradeable permits: Permits to pollute to 5000 ppm

to each driver.

• Tax = $100 per 1000 ppm of emissions.

Marginal cost of reducing emissions by 1000 ppm(evaluated at different levels of emissions)

7000 6000 5000 4000

Junker car (A)

$90 $110 $130 $150

New car (B)

$55 $75 $95 $115

The London congestion charge

• What facts motivated the new policy?• What were practical difficulties associated

with congestion charges? • What program was adopted in 2003?• What are the benefits?• How are payments made?• How were violators detected?• What were the measured impacts?

B.C. carbon tax first in North America

• How does the 2008 B.C. provincial budget address climate change?

• What does it mean to be a “consumer-based tax”?

• What will happen to the revenues?

• Will B.C. residents be financially better off or worse off?

Who bears the cost of a tax?

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Q

MC

MC+tax

P

P’

MB

MC

P

MB

MB after tax

P’

Producer pays Consumer pays

Both consumer and producer pay the same share of the costs regardless of who pays the tax. The share depends on the slopes. Consumers pay high share if demand steep (inelastic).

Greenhouse gases (GHG)

• What are greenhouse gases?

• What are the sources of GHG emissions?

• What are the consequences?

GHG concentration up

Global warming

• Global surface temperatures have increased about 0.74°C (plus or minus 0.18°C) since the late-19th century... The warming has not been globally uniform. Some areas (including parts of the southeastern U.S. and parts of the North Atlantic) have, in fact, cooled slightly over the last century. The recent warmth has been greatest over North America and Eurasia between 40 and 70°N. Lastly, seven of the eight warmest years on record have occurred since 2001 and the 10 warmest years have all occurred since 1995.

http://www.ncdc.noaa.gov/oa/climate/globalwarming.html#q3

Rising sea levels

• Global mean sea level has been rising at an average rate of 1.7 mm/year (plus or minus 0.5mm) over the past 100 years, which is significantly larger than the rate averaged over the last several thousand years.

http://www.ncdc.noaa.gov/oa/climate/globalwarming.html#q3

“Montreal Climate Forum a Struggle for Consensus”

• What is the purpose of the forum and who are the participants?

• What are the consequences of global warming on the environment?

• What are some of the evidence that exists on global warming?

• What is the Kyoto Protocol and its commitments? What important country has not ratified it?

• What countries are meeting their commitments and what countries are not?

Hopes Fade for Comprehensive Climate TreatyNew York Times, October 20, 2009

• Negotiators have accepted as all but inevitable that representatives of the 192 nations in the talks will not resolve the outstanding issues in the brief time remaining before the Copenhagen conference opens in mid-December. The gulf between rich and poor nations, and even among the wealthiest nations, is just too wide.

• So officials are now narrowing expectations and defining the areas where there is agreement, such as the need to halt and then reverse the growth of greenhouse gas emissions, although how and by whom remains the subject of intense dispute. Negotiators are also discussing what form any declaration that emerges from Copenhagen might take and how to ensure that any promises made there are kept.

• Among the chief barriers to a comprehensive deal in Copenhagen is Congress’s inability to enact climate and energy legislation that sets binding targets on greenhouse gases in the United States. Without such a commitment, other nations are loath to make their own pledges.

Trading in pollution• What are the environmental

consequences of S02 emissions? Do they generate negative externalities?

• Why type of program was set up in the U.S.? Was it successful?

• How were emissions monitored? • What are characteristics of markets where

tradable permits have not been so successful?

Carbon neutrality in BC

• “On November 20, 2007, the Greenhouse Gas Reduction Targets Act made B.C. the first jurisdiction in North America to make a legally binding commitment to carbon neutral operations.” http://www.livesmartbc.ca/government/neutral_action_reports.html

• How do you achieve carbon neutrality?

Carbon neutrality

• “Carbon neutrality involves measuring operational GHG emissions, reducing those where possible, offsetting the remainder and demonstrating leadership through public reporting.”

• Who provides offsets?

Offset providers

• The Pacific Carbon Trust has been set up to purchase carbon offsets ($25/ton).

• Offsets or carbon savings are generated from changes made to avoid or absorb (sequester) carbon dioxide, or any of the main greenhouse gases. Typically these GHG-reducing activities fall under three categories:– Renewable energy, such as run-of-river hydro power generation;– Energy efficiency, such as industrial energy efficiency or

switching from oil to natural gas; and– Emissions storage or sinks, such as afforestation (forestation of

land not previously forested).

Demise of the cod fishery on the Grand Banks off Newfoundland

• Most of the fishery lies in Canada's territory (12 mile limit extended to 200 miles in 1977) but some is in international waters.

• Mismanagement by Canada and the North Atlantic Fishing Organization led to near extinction of the cod stock (see chart). The cod fishery was closed in 1992.