Week 10: Air pollution. Key concepts: externalities. Example: transboundary pollution. Flashcards Preview

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Flashcards in Week 10: Air pollution. Key concepts: externalities. Example: transboundary pollution. Deck (28)
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Social Optimum

Marginal benefit (marginal willingness to pay) = Marginal cost (marginal willingness to product)


Adam Smith and Invisible Hand

Market participants that are driven by self-interest lead to a socially optimal outcome and the market is competitive


Problem of externality

- Action by firm/consumer directly impacts another firm/consumer (self-interested parties do NOT incorporate this effect in decision-making)
- Social optimum will not be achieved by self interested partied


Externalities Examples

- Pollution by firms: heal damages on individuals, reduced productivity
- Smoking: consumption and second-hand smoke
- Congestion: crowded subway cars
- Knowledge spillover (positive externality)
- Pollination by bees (positive spillover)


Negative Externality

- Imposes negative effects on others
- Agents tend to produce too much
- Do not incorporate negative effects on others


Positive Externality

- Create positive effects on others
- Agents tend to produce too little
- Do not incorporate positive effects on others


Market-Based Regulations (taxes/subsidies)

- Internalize externality
- Impose per unit tax equal to cost imposed on others
- give out per-unit subsidy equal to benefit on others



Reduction in Pollution/ marginal benefit of abatement is is reduction in externality
- it is cheap/easy to reduce the first unit of pollution but gets consecutively harder to reduce additional units (marginal cost of abatement weakly increasings)
-Marginal benefit of pollution is decreasing in pollution - whoever generates pollution gets "benefit" from doing so, when abatement is feasible marginal cost of abatement is avoided


Command and Control

Government specifies what company have to do to comply : huge information burden, very long regulation (subcategories for various sub-industries), no incentive to innovate once requirements are fulfilled, easier to enforce as each company is told what to do


Command and Control Heterogenous Cost

2 firms: abatement by firm 1: q1 and abatement by firm 2: q2

Government desires combined abatement of q*= q1 + q2

Firms have different MAC curves

If firms are in the same sub-sector both have to abate half: Qcc = q*/2


Command and Control Cost - Reasons for why CC regulations do not equate marginal abatement costs

Possible reasons:
- firms are heterogeneous/have different MACs
- Uncertainty about true MACs (info asymmetries, gov't does not know private MC, assumes firms in sub-sector are comparable)
- Rent seeking (lobbying by some firms) - to get weaker regulation than competitors, have more excess permits


Market-Based Approached: Taxes

Conventional design: tax per unit (i.e. garbage fees per volume or weight) - a negative tax is a subsidy
- Emitters have choice in how much to pollute/abate: abate a unit of pollution (avoid it) or pay per unit tax for all units of pollution


How do firms respond to a tax?

Pick the cheaper option
a. abate if marginal abatement cost MAC is cheaper than tax, or b. pay tax on all units where tax is smaller than MAC


What is the total cost to a firm under a pollution tax?

qFull abatement is the largest possible amount of abatement - cannot abate more unites than there is pollution


Pollution Tax Minimizes Abate Cost

- Every firm equates MAC and tax rate
- All MACs are equalized - impossible to reallocate pollution among parties to reduce cost


Market-Based Approaches: Permits

Permits vs. taxes
- Taxes fix the price and let firms adjust quantity abated
- Permits fix quantity abated and let firms determine permit price

Emitters have choice in how much to pollute/abate: abate unit of pollution (avoid it) or, use/purchase a permit (unused permits of a firm can be sold to other firms)


How are permits allocated?

Either by Auctioning: all emitters have to buy permits from government OR Grandfathering: given out for free based on historic emissions


Equilibrium Permit Price P**

Two companies with different abatement cost curves: gov't wants combined abatement q* =q1 +q2 where the quantity of permits is set to the initial pollution minus q*

Equilibrium permit price P** = height of MACs (where two curves intersect)

- If permits trade for a price larger than P**, then combined abatement is larger than q*, not all permits are sold

- If permits trade for a price smaller than P**, combined abatement is smaller than q*, there are fewer permits available than amount of pollution (some firms don't have a permit for some of their pollution)


Green Taxes

- Economists like them: correct market failures, reduces overall pollution at lowest cost, gov't raises revenue in non-distortionary way
- Revenues can be used to lower other distortionary taxes: environmental/green tax reform, way to lower opposition


Carbon Tax (British Columbia Example)

Implemented in 2008 at $10 per ton of CO2 and finalized in 2012 at $30 per ton of CO2 (generates $1.3B)

- Revenue neutral: used to lower other taxes including individual and business tax rates and individual tad rates for lower income


Carbon Tax (Australia)

Overturned by government
- Was only for domestically consumed goods, no tax on exported coal


Green Taxes on SO2 (Sulfur Dioxide)

- SO2 leads to acidification (damages water and aquatic species as well as trees)
- Get transported over long ranges: some countries don't emit much but receive a lot (trans-national externality), requires an international agreement to combat
- Studies focus on emissions across space and time


Non-uniform Taxes

- Economists advocate market solutions: 1.Pigouvian taxes (internalize externality, impose tax equal to marginal damage at optimum) 2. Tradable permit system: each unit requires a permit to pollute, allows firms to trade.
- Advantage of market solution: 1. same pollution reduction at min cost (firms with lowest abatement costs will abate), 2. big assumption is that it doesn't matter who pollutes


Muller and Mendelsohn (2009)

- Not only abatement costs vary between firms, BUT damages dependent on where pollutant is emitted!
- Implications: NOT necessarily best to impost a uniform tax
- How to restore optimality: non-uniform tax, which allows for difference in marginal damages caused by pollution


What is the optimal reallocation of pollution

Keeping total pollution fixed


Equity vs. Efficiency

Efficiency: different amounts of pollution (ex. should air be cleaner in NYC or Helena)
Equity: if standards are different how do you say what is fair with regards to pollution levels (ex. what is the probability of getting sick, higher in NYC or Helena?


Title IV of Clean Air Act Amendment

- Established SO2 permit trading system
- Cap of 10.2 million tons of SO2


Optimal Tax T**

Gov't wants combined abatement q*= q1 + q2

The required tax T** to achieve abatement q* is set at the height of the marginal abatement cost (intersection of both curves)

If tax is larger than T**, combined abatement is larger than q*

If tax is smaller than T**, combined abatement smaller than q*

Hard to identify T** as gov't needs to know MACs, HOWEVER unlike Command and Control, gov't can learn through iterative processes, lower/increase if abatement is too large or small, respectively