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Econ 100 Lecture 9.2

Taxes, Standards and Tradable Permits 3-04-09. Econ 100 Lecture 9.2. Negative Externality. Marginal Private Costs < Marginal Social Costs. Ideal. Actual. Pi. Pa. Negative Externalities. An Example: Pollution Emitted by factories as a by product of the production process

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Econ 100 Lecture 9.2

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  1. Taxes, Standards and Tradable Permits 3-04-09 Econ 100Lecture 9.2

  2. Negative Externality • Marginal Private Costs < Marginal Social Costs Ideal Actual Pi Pa

  3. Negative Externalities • An Example: Pollution • Emitted by factories as a by product of the production process • Air, water, electricity • Emitted by vehicles • Typically treated as a “zero-cost” input into the production process • Source will be “over” consumed (beyond point marginal benefit = marginal cost as mc = 0)

  4. What Are the Consequences? • Without Intervention • Consumers/producers will not take such costs into economic decisions • Produce too much of the good & externality (e.g., pollution)

  5. Two Big Questions? • What is the optimal level of pollution? • How is that amount allocated among firms/sources?

  6. How Do We Set the Standard? Equate MC of damage To MC of abatement

  7. What Do We Know About the Costs of Reducing Pollution? • Costs of reducing • Additional costs of reducing pollution will be greater when level of pollution is higher • An Example: • First electrostatic precipitator reduces emissions by 80% • Second (added) EP by another 80% • Effectively 80% x 20% (remaining) = 16% • Third EP • 80% x 4% = 3%

  8. What Does the Cost Curve Look Like?

  9. How Do We Set the Standard? Equate MC of damage To MC of abatement

  10. Remedies for Negative Externalities • Standards • Permissible level of emissions for each factory in an industry (each industry gets same target), or • Targets how much emissions must be reduced by each factory (again, same target for all) Taxes • Direct tax on emissions • Indirect on input/output if there is a direct correlation between input/output and pollution • E.g., tax on gasoline, coal based on sulfur content • Tradable permits • Gives each firm the “right” to pollute to a certain level • Firms are allowed to trade/sell permits

  11. Standards • Emission standards • Could be set at same “optimal” amount of pollution as the tax Two approaches • Establishes the level of pollution that can be emitted by “polluter” • Require all firms to reduce pollution by “x” amount • Typically divided up among the firms equally • Disregards technological/cost differences between firms • Therefore will not be cost efficient

  12. Standards • Same amount of pollution for all firms • Newer firms with newer/efficient technology able to easily meet standard and may not even reach it • Same amount of reduction • Newer firms already emitting less • Maybe increasingly more costly for them to reduce pollution by x amount then firms with older technology • Either way • Approach is not cost efficient • Provides no incentive for firms to reduce emissions below standard

  13. Negative Externalities & Taxes • How to Set the Optimal tax • Set at point where MBen = MCost of Pollution • Tax: equals difference between MSC and MPC and • “internalizes” it into the consumption decision • Firm’s cost = price*quantity of inputs plus tax*emissions/output Tax

  14. EmissionTaxes • Emission taxes • Will be cost-efficient • Firms will adopt new technology if marginal abatement costs are less than marginal cost of tax • Otherwise will pay the tax • Consequently firms will adopt least cost approach to meeting optimal pollution goal • Taxes have lower administrative costs • Can be easily raised/lowered to fine tune meeting of the standard • Do not require litigation

  15. Cost-Minimizing Control of Pollution with an Emission Charge

  16. Cost Savings from Technological Change: Charges versus Standards

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