environmental economics

1. environmental economics Chapter 13

2. 2 issues • what is appropriate level of waste? • how to achieve that level (who has to reduce how much?)

3. take usual approach • identify efficient levels of pollution • discuss market levels of pollution • demonstrate how policy can reconcile

4. pollutant taxonomy • stock pollutants: accumulate over time / little or no absorptive capacity • nondegradable materials • heavy metals • fund pollutants: some capacity to be absorbed • organic pollutants • CO2 • efficient allocation depends on nature of pollutant

5. fund pollutants: efficient allocation • if no accumulation, future damage independent of current emissions…can use static framework • max net benefit from pollution • minimize costs: 2 types • damage costs (increasing in pollution) • control / avoidance / abatement costs (decreasing in pollution)

6. efficient allocation of a fund pollutant

7. efficiency: MCC = MDC • points left of Q* (less pollution) inefficient • cost > benefit in damages avoided • points right of Q* (more pollution) inefficient • damages > cost of cleanup • increasing or decreasing control would increase TC

8. optimal pollution not zero • cases where could be very close to zero • MDC of first unit > first unit MCC (plutonium?) $ MDC MCC pollution

9. market allocation of pollution • damage costs externalities; control costs not • cheap to a firm not cheap to society • problem particularly severe with stock pollutants • extra burden on future generations due to accumulation

10. policy responses • how to achieve MCC = MDC? • legal limits (Q*) • internalize damage through tax / charge system

11. easy in theory / difficult in practice • need to know Q where 2 MC’s cross for every emitter (high information costs) • alternative: select Q based on other criteria • safe for human / ecological health • then, how to allocate responsibility for meeting this level? • use cost-effectiveness criterion • not necessarily optimal, but minimizes cost given some level Q

12. cost-effective allocation: example • assume 2 sources currently emitting 30 units • reduce to 15 units • how to allocate reduction between 2 sources?

13. cost-effective reductions

14. cost-effective reductions • source 1 cleans up 10 units (cost A) • source 2 cleans up 5 units (cost B) • any other allocation…higher TC (area bigger)

15. demonstrates important proposition • cost of achieving given reduction in emissions will be minimized if and only if MC of control (abatement) equal across emitters • what policy instrument to achieve equality? • emissions standards • emissions charges • emissions trading

16. emissions standards • command and control • equal reduction? • not cost-effective • first source lower cost • total costs increase if both forced to clean up same

17. emission charges • fee on each unit emitted • profit-maximizing firm controls rather than emits when cheaper to do so

18. cost-minimizing control of pollution with an emission charge

19. emission charges • if no pollution control, pay OTBC • best can do? • no: cheaper to pay to reduce emissions until MC reduction = emissions charge • minimizes cost by cleaning up 10 units and emitting 5 units • pay OAD in control, ABCD in emission charges, total costs OABC < OTBC

20. emission charges • if levied same charge on both, each source would control until MC = charge, and independently choose levels of control consistent with equal MC costs • as long as authority imposes same charges, automatically minimize TC of control • despite lack of information on firm’s costs

21. how to SET appropriate emissions charge? • iterative trial and error • choose rate, observe reduction • if too large, reduce • if too small, increase • charges not only create cost-effective allocation, also stimulates technological progress

22. cost savings from technological change: charges versus standards

23. charges vs. standards • standard based on specific technology • as new technology discovered, standards tightened • firms have incentive to HIDE technological advances • with charges system, firm saves $ (A+B) if can reduce pollution at MC < T • voluntarily reduces emissions from Q0 to Q1

24. transferable emission permits • can identify cost-min allocation without trial and error • all sources required to have permits to emit • freely transferable • authority issues exactly # permits needed to produce desired emission level

25. emissions permit system

26. emissions permit system • suppose source 1 has 7 permits (1 permit = 1 emission unit) • controls 8 units • suppose source 2 has 8 permits • controls 7 units • both firms have incentive to trade (MC2>MC1)

27. emissions permit system • source 2 can lower cost by buying permit from source 1 at price < C • source 1 better off selling permit at price > A • transfer until • source 1 has 5 permits (controlling 10) • source 2 has 10 permits (controlling 5) • permit price = B • neither source had incentive to trade further

28. other issues with instruments • revenue effect • taxes / charge system raises revenue; permits do not • may be “double dividend”…use revenue to offset other taxes

29. another issue: uncertainty • cost of being wrong MCC MDC $ $ use charges MDC MCC use permits emissions controlled emissions controlled Prevent large fluctuations in damage costs Prevent large fluctuations in control costs