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Economic Strategies for Regulating Pollution: Instruments and Impacts

This article explores how economics can guide regulatory approaches to managing pollution from industries. It examines the rationale behind regulation, the inefficiencies of free markets, and the impact of externalities, market power, and information problems. Key concepts such as the optimal amount of pollution, marginal control costs, and abatement strategies are analyzed. Different regulatory instruments like taxes, quotas, and tradable permits are discussed, highlighting their effectiveness in promoting efficient pollution reduction, as exemplified by case studies from China and Rhode Island.

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Economic Strategies for Regulating Pollution: Instruments and Impacts

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  1. Regulatory Options & Efficiency What guidance can economics provide about how to regulate polluting industries or firms?

  2. Why regulate? • Does free market efficiently provide goods and services? • Market failure (externalities, public goods, etc.) • Market power (monopolies inefficiently restrict production to raise prices) • Information problems (damages uncertain, food safety, env quality)

  3. Types of questions in regulation • What is the “optimal” amount of pollution? • To reduce by X%, who should reduce and by how much? • What regulatory instrument(s) should be used to achieve that level?

  4. The efficient amount of pollution Marginal Control Cost $/unit Marginal Damage Cost Total Damage Cost Total Control Cost Q* Units of pollution

  5. Recall example from 1st day • 60 firms, each pollute 100 tons • 30 low abatement cost ($100/ton) • 30 high abatement ($1000/ton) • Everyone reduces 1 ton: Cost=$33,000 • Total reduction = 60 tons. • For same cost could have reduced 330 tons.

  6. If low cost firms abate: Either: • Reduce more pollution for the same amount of money…or • Reduce the same amount of pollution for less money. So we always want low-cost firm to abate.

  7. If costs aren’t constant: greenhouse emissions of Nitrogen Cost ($) Who should abate the 1st unit of N? MCA MCB  N

  8. How much abatement from each? $ (A) Loss from equal reduction MCA $ (B) MCB A: 0 40 25 80 80 B: 55 40 0

  9. How did he do that? • Determine how much total abatement you want (e.g. 80) • Draw axis from 0 to 80 (A), 80 to 0 (B) • Sum of abatements always equals 80. • Draw MCA as usual, flip MCB • Lines cross at equilibrium • Price is MC for A and for B.

  10. The “equimarginal principle” • Not an accident that the marginal abatement costs are equal at the most efficient point. • Equimarginal Principle: Efficiency for a homogeneous pollutant requires equating the marginal costs of control across all sources.

  11. Control costs • Should include all other costs of control • monitoring & enforcement • administrative • Equipment • High cost firms have incentive to innovate and change production technology • Regulatory uncertainty increases costs.

  12. Instruments for regulation • Taxes: charge $X per unit emitted. This increases the cost of production. Forces firms to internalize externality. • Quotas/standards: uniform standard (all firms can emit Y) or non-uniform. • Tradable permits: All firms get Y permits to pollute, can buy & sell on market. Other initial dist’n mechanisms.

  13. Example 1: Taxes in China • China: extremely high air pollution – causes significant health damage. • Instituted wide-ranging system of environmental taxation • 2 tiers • World Bank report estimates that MC of abatement << MB of abatement.

  14. A creative quota: bubble policy • Multiple emissions sources in different locations. • Contained in an imaginary “bubble”. • Regulation only governs amount that leaves the bubble. • May apply to emissions points within same plant or emissions points in plants owned by other firms.

  15. Example 2: Bubble policy in RI • Narraganset Electric Company: • 2 generation facilities in Providence, RI. • Required to use < 2.2% sulfur in oil. • Under bubble policy: • Used 2.2% in one plant, burned natural gas at other plant • Savings: • $3 million/year

  16. $/unit MSC MPC P* MEC Pp D Q* Qc Dirty Good

  17. What tax or quota is required? • We know: • Optimal level of pollution is Q* • Marginal Social Cost at the optimum is P* • Marginal Private Cost at optimum is Pp. • Optimal tax exactly internalizes externality: • t* = P* - Pp • Effectively raises MC of production

  18. MPC (with tax) $/unit MSC t* MPC (no tax) P* Pp D Q* Qc Q (pollution)

  19. Taxing consumption instead • Taxing consumption: • Taxing consumers for every unit of a polluting good that is purchased. • E.g. Automobile gasoline • Can equivalently be used: • Instead of raising production costs, a consumption tax lowers demand.

  20. $/unit MSC MPC (no tax) P* Pp t* D (no tax) D (with tax) Q* Qc Q (pollution)

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