copyright © 2008 pearson addison-wesley. all rights reserved. chapter 17 the economics of...

Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Chapter 17

The Economics of Environmental Protection

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 17-2

In this chapter you will learn to

1. Describe how an externality can be internalized, and how this can lead to allocative efficiency.

4. Describe and evaluate some of the most common arguments against market-based environmental policies.

3. Explain why market-based policies such as emissions taxes and tradable pollution permits can improve economic efficiency.

2. Explain why direct pollution controls are often inefficient.


Pollution as an Externality

The production of most goods generates some pollution that imposes costs on other members of society.

The Economic Rationale forRegulating Pollution

The socially optimal level of output is at the quantity where all marginal costs, private plus external, equal the marginal benefit to society.


One solution is to internalize the externality – a process that results in a producer of consumer taking the account of a previously external effect.

Pollution is a negative externality.

- the social marginal cost of production exceeds the private marginal cost of production.

Negative Externality


Figure 17.1 A Pollution Externality in a Competitive Market

With a negative externality, MCs exceeds MCp...

… with the result that too much gets produced.


How can this be achieved?

If the externality can be internalized (by making the producers bear the full external cost), allocative efficiency can be achieved.

The socially optimal level of output is where the social marginal costs -- private plus external -- equal the marginal benefit to society.

Internalizing Externality


Figure 17.2 The Optimal Amount of Pollution Abatement


Direct control is a form of environmental regulation that either:

• stipulates the use of specific technology, or

• prohibits certain polluting behaviour altogether.

Pollution-Control Policies

Direct Controls


The use of direct controls is usually economically inefficient:

- because the MC of abatement is not equated across different firms

Problems with Direct Control

Direct pollution controls are inefficient because they do not minimize the cost of a given amount of pollution abatement


Figure 17.3 The Inefficiency of Direct Pollution Controls

Direct pollution controls usually do not minimize the cost of a given amount of pollution abatement.


Figure 17.4 The Efficiency of Emissions Taxes

With a tax of $t per unit of pollution emitted, the tax becomes the firm’s marginal benefit of pollution abatement.


Set the emissions tax equal to the size of the marginal external cost

- this fully internalizes the externality

APPLYING ECONOMIC CONCEPTS 17.1

Garbage Collection and “Pay-As-You-Throw”

But the information required to know the optimal tax rate is often unavailable.

Efficient amount of pollution


The government could issue (or auction) a given number of tradable emissions permits.

The price of the permit is the MB of abatement.

Firms will abate pollution until the MB equals the MC.

Pollution is abated at minimum cost.

Tradable Emissions Permits

This kind of problem is also called “cap and trade.”


Figure 17.5 The Efficiency of Tradable Emissions Permits


With an emissions tax, government must determine the optimal tax rate.

With pollution permits, the market for permits determines the equilibrium permit price, but government needs to set the total amount of permits.

So how does the government set the optimal quantity that leads to the optimal equilibrium price -- the one that fully internalizes the externality?

Pollution Permits


Figure 17.6 The Market for Tradable Emissions Permits


Technological Change

Government regulation tends to respond only slowly to changes in technology or market conditions.

Improvements in abatement technology will lead to a reduction in the demand for emissions permits and thus a reduction in their equilibrium price.

The total cost of a given amount of pollution abatement will still be minimized.


The U.S. Experience with Tradable Emission Permits

The cap and trade approach has been implemented in:

– California’s 2006 greenhouse gas reduction program

– Kyoto Protocol’s strategy for greenhouse gas reduction

Problems with Tradable Emissions Permits

Technical difficulties in measuring pollution and in designing mechanisms to ensure that firms and households comply with regulations.

Tradable Emission Permits


The Politics of Pollution Control

Several groups argue against the use of market-based environmental policies

- especially tradable pollution permits

But the growing concern about global warming and the debate over the Kyoto Protocol have led to more discussion and growing acceptance of the basic principles.


Producers

Emissions taxes or permits are costly, and firms naturally complain.

These policies, if implemented, signal the end of a free ride that firms have been taking at society’s expense.

Firms also argue that such policies reduce overall welfare because of reduced output and employment:

- but reduced output of the polluting products is part of the solution that increases welfare!


The General Public

But the relevant question is: How can society best reduce pollution?

Emissions taxes and tradable emissions permits lead to pollution reduction with the least cost.

There is also opposition to having some firms reduce pollution less than others. Shouldn’t they reduce by equal amounts?

Some people have a moral opposition to giving anyone the “right” to pollute.


Environmentalists

They often don’t see how private firms could ever be induced to do what is desirable for society. As a result, they tend to prefer the use of direct controls.

Some argue that clean air and water are above monetary evaluation and should be treated in special ways.

Economists can emphasize that market-based schemes are often more efficient than other policies -- which means more pollution abatement with a given amount of resources.


Summary

The efficient solution to pollution involves internalizing the externality.

If properly designed, such market-based environmental policies can reverse the effects of the pollution externality.

However, there is considerable opposition among some environmentalists and some of the general public to market-based environmental policies.

Tradable emission permits also generate skepticism due to the failure to appreciate how markets work to allocate resource efficiently.

copyright © 2008 pearson addison-wesley. all rights reserved. chapter 17 the economics of...

Documents

pollution externality

pollution abatementfigure

unit of pollution

tradable pollution permits

marginal external cost

emissions tax equal

optimal tax rate

social marginal costs