Demonstration

1. The Pollution Game:A Classroom Demonstration Comparing the Relative Effectiveness of Pollution Control PoliciesJay R. Corrigan MCAce MCDeuce MCDeuce MC/MB MC/MB MC/MB MCAce MCPerceived MCPerceived MCPerceived MCAce Both firms must pursue same level of abatement MCSociety MCSociety MCSociety Private information Deadweight loss from inefficient allocation of abatement. Expect additional loss from imperfect choice of cap. Sum of firms’ curves Deadweight loss from too much abatement Tax MBSociety MBSociety MBSociety Perceived abatement costs may be greater than true abatement costs if firms overstate their costs Deadweight loss from too little abatement MCDeuce APermits ATax Abatement Abatement Abatement AbatementAce AbatementDeuce Kenyon College Motivation Students in undergraduate environmental economics courses learn that while pollution creates a negative externality, governments can employ a variety of policies in order to achieve economic efficiency, such as command-and-control, emissions fees, or tradable emissions permits. But little time is generally spent discussing the relative strengths of these policy options in a world of asymmetric information and uncertainty. This demonstration is designed to illustrate the relative efficiency of various government policies aimed at internalizing negative externalities, as well as problems that arise due to heterogeneous abatement costs, asymmetric information, and strategic behavior on the part of regulated firms. Demonstration The class is divided into three groups: the government regulatory agency, Ace Energy, and Deuce Petrochemical. The government’s task is to reduce pollution to the efficient level while minimizing the costs imposed on industry. The firms want to minimize total abatement costs. Each firm’s abatement cost is private information. Government, in communication with firms free to respond strategically, designs a uniform standard for all firms, a system of emissions fees, and a cap-and-trade framework. Successively implementing these three strategies gives students a sense of the policies’ relative strengths in the presence of asymmetric information and resulting uncertainty on the part of government. Likely Outcome Estimating Abatement Cost Uniform Standard Tradable Permits Emissions Fees • Do firms have an incentive to misstate their true abatement costs? How does this incentive differ across emissions fees and tradable permits? What can government do to minimize this kind of strategic behavior? Why would you expect emissions fees to outperform tradable permits when marginal abatement costs are uncertain and relatively steep? Why would the opposite be true if the marginal benefit from abatement were relatively steep? Which scenario is more realistic for a pollutant like CO2? Topics for Discussion