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SYRACUSE / Economics / ECN 437 / Given that some target level of emissions (or pollution concentration)

Given that some target level of emissions (or pollution concentration)

Given that some target level of emissions (or pollution concentration)

Description

Study Guide for ECN 437  


Given that some target level of emissions (or pollution concentration) has been chosen, what is the best method of achieving that level?



COASE THEOREM

-While it might not matter for efficiency which way the judge rules, the parties care about the outcome  of his ruling.  

-The efficiency argument of the Coase theorem

• It doesn’t matter which way the judge rules in terms of whether the surplus maximizing action  will be taken.

o If it is socially efficient for the views to be blocked (privacy), the trees will stay no matter  how the judge rules

o If it is socially inefficient for the views to be blocked (pristine views), the trees will have  to go regardless of how the judge rules.

• But the ruling does have an impact on how the social surplus is divided between them. Barriers that keep people from bargaining  


What is the total abatement cost functions of the two firms?



• To get their way out of an externality problem once property rights are fully defined.  • These barriers are transaction costs.  

o These costs cannot be neglected.  

• Coase Theorem: – “If transaction costs are sufficiently low the efficient outcome will arise in  the presence of externalities so long as property rights are sufficiently clear.

o Airline seats example

*Efficient output with pollution damage graph*

Individual Negotiations

• It raises two questions:  

1) Should the property right always belong to the party who held it first?  

2) How can environmental risks be handled when prior negotiation is clearly impractical? • These questions are routinely answered by the court system.


Why value the environment?



Don't forget about the age old question of How is money distributed to the business owners taxed? is it possible that owners may have to pay taxes on money attributed to them as income but have not received them?

The Courts: Property Rules and Liability Rules

•Property rules specify the initial allocation of the entitlement (the right to cut trees or let them grow) We also discuss several other topics like How does descartes refute skeptics?

o In applying property rules, the court merely decides which right is preeminent and places an  injunction against violating that right.

• Liability rules can also correct inefficiencies by forcing those who cause the damage to bear the cost of  that damage.  

o Internalizing previously external costs causes profit maximizing decisions to be compatible with  efficiency.

o Cleaning oil spill and compensate fishermen for reduced catches.

Regulation (Fundamentals)

• Economic analysis of environmental policy Don't forget about the age old question of What are the diseases associated with aids?

o Based on the idea that the harmful consequences of economic activities on the  environment constitute an externality.  

o But agents do not have an economic incentive to minimize the external costs of  pollution.  

o Environmental policies attempt to equalize this imbalance by raising the incentive for a  firm to minimize this externality

• Policy choices accomplish this in one of two general ways  

o Market-Based Approaches

• Financially internalizing the environmental costs so polluters make their own  decisions regarding their demand for environmental inputs

o Command and Control

• Imposing a limit on the level of environmental pollution

Absence of Property Rights  

• Property Rights

o The set of valid claims to a good or resource that permit the use and transfer of  ownership through sale.

o These rights are generally limited by law and/or social custom.

o In the context of environmental goods, it is unclear who “owns” rights. Don't forget about the age old question of Who is rev. billy graham?

▪ Economics says it is the absence of rights that matters, not who possesses them.  • China’s Pearl Delta Region

Coase Theorem

• Proper assignment of property rights

o Even if externalities are present, it will allow bargaining between parties such that  efficient solution results, regardless of who holds rights  

o Assumes costless transactions  

o Assumes damages are accessible and measurable

• Building the Model Refined Petroleum Market  If you want to learn more check out How to calculate how many calories are in a portion of food?

o Refineries use the river to release chemicals as an unintended byproduct of production ▪ Objective: to maximize profit

o Recreational users use the river for swimming and boating  

▪ Objective: to maximize utility

• Bargaining when Rights Belong to Refineries

o Recreational users are willing to pay (WTP) refineries for each unit of Q not produced ▪ Will pay up to the negative effect on utility (MEC)

o Refineries are willing to accept payment not to produce  

▪ Will accept payment greater than their loss in profit from contracting  

production (Mprofit) We also discuss several other topics like What is the major problem with the monoamine hypothesis of depression?

• Bargaining When Rights Belong to Refineries  

o Initial point is Qc, since the refineries, who own the rights, would choose this point  o Recreational users:  

▪ Willing to offer a payment p

• P < (MSC - MPC), or p < MEC

o Refineries:  

▪ Willing to accept payment p

• P > (MPB - MPC), or p > Mprofit

*Bargaining Process graph*

• Bargaining should continue as long as

o (MSC - MPC) > p > (MPB - MPC) or  

o MEC > r > Mprofit •  

• At QC: Refineries’ Mprofit = 0, but MEC > 0, (distance XY)

o Since MEC > Mprofit, bargaining begins  

• Between QC and QE, same condition holds

• At QE: MEC = Mprofit, (distance WZ); output reductions beyond this point are infeasible, since  Mprofit > MEC

Bargaining When Rights Belong to Recreational Users

• Bargaining will proceed analogously  

• An efficient outcome can be realized without government intervention

• Limitations of the Coase Theorem

o Assumes costless transactions and measurable damages

o At minimum it must be the case that very few individuals are involved on each side of  the market

POLLUTION CONTROL: TARGETS

• In thinking about pollution policy, the economist is interested in two major questions:  1) How much pollution should there be?  

2) Given that some target level of emissions (pollution concentration) has been chosen, what is  the best method of achieving that level?  

• The question is: How much of a particular pollutant should be emitted annually at the national  level? Will you arrive to the same conclusion?

The concept of a pollution target

• Unless government takes the view that pollution levels should be decided entirely by free  market outcomes, a policy maker will, for a particular pollution problem, need to make a  decision about how much pollution should be permitted.

o Pollution targets may be based on what risk to health is deemed reasonable. o They may be based on what is acceptable to public opinion (Yellow Vests in France).  Policy is influenced very strongly by the interplay of pressure groups and interests.

*Maximum Permissible pollution levels graph*

 

• The target level of emissions (or pollution) resulting from any analysis depends on the modelling  framework employed, particularly its breadth  

o Breadth might refer to geographical or political scope (e.g. carbon emissions from US  alone or the rest of the world)

• It may also refer to the framework used:  

o Partial equilibrium or general equilibrium analysis

▪ A partial equilibrium approach looks at a single market (e.g. electricity) or  

activity, in isolation from the rest of the economic system

▪ A general equilibrium framework looks at the interactions of all the elements of  the entire economic system  

Modelling Pollution Mechanisms  

• Determine the level of pollution (pollution targets), using the criterion of economic efficiency.  o Economic activity generates emissions flows that impose pressures on the environment • The extent to which these pressures generate impacts that are associated with subsequent  damage depends on several things ⇒ e.g. the location of the environmental receptor, the  assimilative capacity of the receptor, people’s tastes, etc.

o Some proportion of the emission flows is quickly absorbed and transformed by the  environment into harmless forms  

o Some proportion of pressures will, in any time interval, remain unabsorbed or  untransformed (e.g. radioactive material)  

 

 

 *Damage impacts of two power plants*

Pollution flows, pollution stocks and pollution damage

• Flow-damage pollution (M)

• Occurs when damages result only from the flow of residuals; that is, the rate at which they are  being discharged into the environmental system

• By definition, for pure cases of flow-damage pollution (e.g. noise or light), the damage will  immediately drop to zero if emission flows stop

o Example: Noise: when the energy emission is terminated no residuals remain in  existence.

• Stock-damage pollution (A)

• Describes the case in which damages depend only on the stock of the pollutant in the relevant  environmental system at any point in time (e.g. concentration of CO2 in 1998)

• For a stock of the pollutant to accumulate, it is necessary that the residuals have a positive  lifespan and that emissions are being produced at a rate which exceeds the assimilative capacity  of the environment (e.g. heavy metals)  

o Extreme cases: Absorption capacity is zero. Metals such as mercury or lead accumulate  in soils, aquifers and biological stock (fish), and subsequently in the human body,  causing major damage to human health.

Economic Activity, Residual flows and environmental damage

 

Pollution flows, pollution stocks and pollution damage

At = aAt-1 + Mt

• a = 0 then At = Mt

• a = 1 then no assimilation -> irreversible growth in the stock.

Residual Flow and Environmental Damage

• Most important pollution problems have the attribute of a stock-damage pollution effect being  present  

• Besides the intuitive impact upon human health, agriculture, etc. pollution stocks may have an impact also on the assimilative capacity of the environment

• Nonetheless, from a regulatory perspective is difficult to regulate stocks, but it is often possible  only to act on flows  

• If M=pollution flow, A=pollution stock and D=pollution damage, then we have two damage  functions:  

– Flow-damage pollution: D = D(M)  

– Stock-damage pollution: D = D(A)

In sum

• Some emission flows will be quickly absorbed and transformed into harmless forms.

• Carrying capacities will be insufficient to deal with all wastes and in extreme cases the carrying  capacities will be zero.

• Physical and chemical processes take time to operate.  

• We can have environmental damage at the time of their emission, and may also, by accumulating as  pollution stocks, cause additional damage.

The efficient level of pollution emissions

• Pollution targets can be set using an economic efficiency criterion. Given that pollution is harmful, we  can argue that only a zero level of pollution is desirable.

• Zero pollution is not efficient, except in special circumstances. In what sense is pollution beneficial?

– Polluting activities also generate economic values

– Generally the marginal damage function starts from low values and is finite  

• Less pollution is preferred to more. But it may not be possible to keep “other things equal” as pollution  level is altered.

The efficient level of pollution emissions  

• If producers of goods and services act rationally, they will select private cost-minimizing techniques of  production, which generate harmful emissions as by-product (externality)  

• Production yields a benefit to the producer (polluter) and a damage to the pollute (i.e. the subject  which suffers from the externality)

•Damages can be thought of as a negative (adverse) externality  

– In many cases the externality happens to be a public bad, in that once it has been generated, no one  can be excluded form suffering its damaging effects

. The efficient level of pollution

With both benefits and costs, economic decisions about the appropriate level of pollution involve the  evaluation of a trade-off.  

• If a regulator requires that producers reduce these emissions, then emissions can be reduced if output  of the product is reduced.  

• Stricter pollution targets will not only generate benefits but will also generate costs.  

– The trade-off is optimized at the point where the marginal benefits arising from reduced pollution  damage fall to a level equal to the marginal benefit from avoided control costs.

– A simple static model can be used to identify the efficient level of a flow of a pollutant. – An efficient  level of emissions is the one that maximizes the net benefits from pollution.

– Recall the PMB=EMC condition for an efficient level of externality

Costs and Benefits of pollution  

• An efficient level of flow pollution M is the one for which net benefits are maximized. • This is equivalent to the outcome where the pollution externality is fully internalized.  – Net benefits ⇒ B(M) − D(M)  

– Condition ⇒ MB(M) = MD(M)

• Costs of pollution abatement.  

• Matters are less obvious with regard to the benefits of pollution.

Maximized Net Benefits

Efficient level of pollution

Pollution Control: Instruments

• Here we consider how an EPA could attain a predetermined pollution target by investigating the  instruments that could be used.

Pollution Policy

• Objectives of pollution policy:  

– Sustainability and ecological goals (e.g. minimum disruption to ecosystems, maintenance of  biodiversity)  

– Human health protection

– Public preferences

In thinking about pollution policy, the economist is interested in two major questions:  1. How much pollution should there be?

2. Given that some target level of emissions (or pollution concentration) has been chosen, what is the  best method of achieving that level?  

We focus on the second question, i.e. “Given that some target level of emissions (or pollution  concentration) has been chosen, what is the best method of achieving that level”?

Economic Theory contributes to both phases

Criteria for Selection of Pollution Control Instruments  

Cost efficiency and cost-effective pollution abatement instruments

• Suppose a list is available of all instruments which are capable of achieving some predetermined  pollution abatement target.

• If one particular instrument can attain that target at lower real cost than any other can then that  instrument is cost-effective.

– Strictly speaking, an instrument is cost-effective if its real resource cost is no greater than that of any  other instrument available.  

• Cost-effectiveness is clearly a desirable attribute of an instrument.

– Using a cost-effective instrument involves allocating the smallest amount of resources to pollution  control, conditional on a given target being achieved.  

– It has the minimum opportunity cost.  

– Hence, the use of cost-effective instruments is a prerequisite for achieving an economically efficient  allocation of resources.

Least-Cost Theorem of Pollution Control

• Let us explore some ramifications of the cost effectiveness criterion.  

• There will be many sources of an emission and so many potential abaters.  

• Main Question: How the overall target should be shared among the sources?

• The principle of cost efficiency provides a clear answer:  

• A necessary condition for abatement at least cost is that the marginal cost of abatement be equalized  over all abaters.  

• This result is known as the least-cost theorem of pollution control.

Least Cost Example  

• Consider a situation in which marginal abatement costs were not equalized.  

• For example, suppose that at present abatement levels two firms, A and B, have marginal abatements  costs of 60 and 100 respectively.  

• Clearly, is B did one less unit of abatement and A did one more (so that the total abatement is  unchanged) there would be a total cost reduction of 40.

• Cost savings will accrue for further switches in abatement effort from B to A as long as it is more  expensive for B to abate pollution at the margin than it is for A.

Suppose the government wishes to reduce the total emission of a particular pollutant from the current,  uncontrolled, level M = 90 to a target level M* = 50

– This implies that the abatement target is 40 units of emission per period.

– Emissions arise from the activities of two firms, A and B. Firm A currently emits 40 units and B emits  50 units.

– The quantity of pollution abatement by the ith firm is

Zi = Mi – M*i

• Suppose the total abatement cost functions of the two firms are:

Therefore, the marginal abatement cost functions are:

Marginal Abatement Cost Functions for the two firms

Marginal Abatement

Marginal Abatement Cost Functions for the two firms

Least Cost Example

Some Important Conclusion

A least-cost control regime implies that the marginal cost of abatement is equalized over all firms  undertaking pollution control.  

• A least-cost solution will in general not involve equal abatement effort by all polluters.  

• Where abatement costs differ, cost efficiency implies that relatively low-cost abaters will undertake  most of the total abatement effort, but not usually all of it

Solutions to Pollution

• Private solutions

– Assignment of property rights and bargaining (Coase Theorem)  

• Public Solutions  

– Direct Regulation (command and control; CAC)

– Market-based instruments  

• Pigouvian Taxes

• Pollution permits  

• Subsidies

Command and Control Instruments

The dominant method for reducing pollution in most countries has been the use of direct control over  polluters.  

– Definition of standards, obligations and prohibitions  

• This set of controls is commonly known as command and control instruments

• Command and control instruments can be designed to intervene at any stage of  production/consumption  

• Regulations may apply to emissions themselves, to the quantity of final production, to the production  techniques that are employed, or to the level and/or mix of productive inputs  

• It can consist on the ban of an input, the obligation to use a certain technology, the obligation to move  locate certain productive activities in a certain area, etc.

Non-transferable Emissions Licenses

• Suppose that the government is committed to attain some overall emissions target for a particular  pollutant  

• The government thus creates licenses (also known as permits or quotas) for that total allowable  quantity

• After adopting some criterion for apportioning licenses among the individual sources, the licenses are  distributed to sources of emissions (e.g. factories)  

• These licenses are non-transferable the licenses cannot be transferred (exchanged) between firms

• Each firm's initial allocation of pollution licenses sets the maximum amount of emissions that it is  allowed

The environmental target can be attained by license schemes only if polluters believe their action are  observed/monitored or if the penalties on polluters that pollute beyond the license are high relative to  the cost of abatement  

• License schemes have to be supported by costly monitoring systems and by sufficiently high penalties  for non-compliance  

• In presence of information asymmetries (marginal costs of each factory is observable only by the  factory itself and not by the government), nontransferable emissions licenses will not be cost efficient  

• Main issue: how to distribute licenses to factories?  

• No `continuous' price on pollution → price is zero up to the point in which the amount of licensed  emissions is reached, then becomes very large (and sometimes not even linked to the level of excess  pollution) beyond this point → little/no incentive to over-abate emissions

Minimum Technology Requirements

Command and control regulations that specify mandatory requirements for production processes or  specific equipment to be adopted  

• Minimum technology requirements are imposed upon potential polluters  

• Examples

– Best practicable means (BPM)  

– Best available technology (BAT)  

– Best available technology not entailing excessive cost (BATNEEC)  

– Catalytic converters for cars  

– Ban of incandescent light bulbs  

• In some variants of this approach, specific techniques are mandated, such as the use of fuel-gas  desulphurization equipment in power generation or minimum stack heights

Location Choices

• Pollution control objectives could be met by separating the location of people and pollution sources  

• This is only relevant where the effects of pollution generate local damages (e.g. ozone precursors,  while GHGs only entail a global uniform damage)

• Separation can occur ex ante or ex post  

– Ex ante zoning or planning control  

– Ex post think about displacing people from contaminated areas (e.g. Chernobyl)  

• Location decisions of this kind will not be appropriate when we are also concerned about the impact  of pollution on ecosystem services and not only about impacts on human health

Command and Control Assessment

• Attractive properties of command and control instruments  

– Certainty of outcome  

– Ability to get desired results very quickly  

– Little information is needed  

• Unattractive properties of command and control instruments  

– Likely to be cost-inefficient  

– They do not contain any mechanism that induce:  

– Equalization of marginal abatement costs across emitting sources  

– Equalization of marginal abatement costs across different programs (e.g. SO2 vs NOx abatement)  – Lack of dynamic incentives no premium for over-abatement

Valuing Environmental Changes

• Changes in these levels are a product of private actions, such as waste disposal or oil spills, or because  public actions, such as new environmental regulations (disruption of current systems).

Exxon Valdez → Set stage for Non-market Valuation

-providing monetary estimates of environmental damages

• Exxon Valdez oil tanker spilled 11 million gallons of crude oil off the Coast of Alaska on March 24th,  1989. Exxon Mobil accepted the liability for the damage caused by the liking oil.  

(1) The cost of cleaning up the spilled oil and restoring the site insofar as possible.  (2) Compensation for the damage caused to the local ecology.  

– 2.1 billion was spent on cleaning efforts, 303 million to compensate fishermen, punitive damages for  2.5 billion.  

• In the spring of 2010, the Deepwater Horizon, a BP well in the gulf of Mexico, exploded and began  spewing an Exxon Valdez oil spill every 4 to 5 days. More than 200 million gallons had been spread  through the Gulf of Mexico (20 times greater than the 1989 oil spill).

– 42.4 billion: Clean up costs, potential penalties, and damage claims

How can the economic damages from spills like these that caused substantial and economic harm be  calculated?  

– Thousands of birds have died from these spills. What are they “worth”?

Why value the environment?  

– Federal agencies rely on benefit-cost analysis for decision making.  

– These analyses frequently fail to incorporate important non-market values.

• Should humans place an economic value on the environment?

Many federal agencies depend on benefit  

– cost analysis for decision making. The goal is to choose economically desirable projects, given  limited budgets.  

– Natural resources damage assessments, such as for oil spills (National Oceanic and  Atmospheric Administration);

– For the designation of critical habitat under the Endangered Species Act (U.S. Fish and Wildlife  Service)

– Dam relicensing applications (The Federal Energy and Regulatory Commission) Valuation

We begin by exposing some of the special challenges posed by pollution control. The damages  by pollution can take many forms. The most obvious, is the effect on human health.  

• Assessing the magnitude of the damage requires:  

1. Identify the affected population.  

2. Estimate the physical relationship between pollutants and the damage to the affected  populations.  

3. Estimate the cost of mitigating the damage.  

4. Place a monetary value on the unmitigated physical damage.

Types of Value

• Economists decompose the total economic value conferred by resources into three main components:  – Use Value  

• The willingness to pay for direct use of the environmental resource  

– Option Value  

• The willingness to pay for the future ability to use the environment

– Passive-use Value (Non-consumptive Use Value)  

• Individuals’ willingness to pay to preserve a resource that he or she will never use ! TWP = UV + OV + NUV

Environmental Ethics

Biocentrism: Places the biologic world (primarily nonhumans) at the center of its value system.  – An important distinction made between instrumental value and intrinsic value. Instrumental value (Use Value) pertains to usefulness.

Intrinsic value (non-use value) does not pertains to usefulness. Something can be totally useless and  still have an intrinsic value.  

• Biocentrism is the philosophy that all living things have intrinsic value regardless of their instrumental  value.  

• One type of non-use value is a bequest value: future generations. A second type of non-use value is  called existence value

Valuation  

Classifying Valuation Methods

– Revealed preference method  

• Methods which are based on actual observable choices and from which actual resource values can be  directly inferred  

– Stated preference method

• Methods to elicit respondents’ willingness to pay when the value is not directly observable  • Each method includes both indirect and direct techniques.

Study Guide for ECN 437  

COASE THEOREM

-While it might not matter for efficiency which way the judge rules, the parties care about the outcome  of his ruling.  

-The efficiency argument of the Coase theorem

• It doesn’t matter which way the judge rules in terms of whether the surplus maximizing action  will be taken.

o If it is socially efficient for the views to be blocked (privacy), the trees will stay no matter  how the judge rules

o If it is socially inefficient for the views to be blocked (pristine views), the trees will have  to go regardless of how the judge rules.

• But the ruling does have an impact on how the social surplus is divided between them. Barriers that keep people from bargaining  

• To get their way out of an externality problem once property rights are fully defined.  • These barriers are transaction costs.  

o These costs cannot be neglected.  

• Coase Theorem: – “If transaction costs are sufficiently low the efficient outcome will arise in  the presence of externalities so long as property rights are sufficiently clear.

o Airline seats example

*Efficient output with pollution damage graph*

Individual Negotiations

• It raises two questions:  

1) Should the property right always belong to the party who held it first?  

2) How can environmental risks be handled when prior negotiation is clearly impractical? • These questions are routinely answered by the court system.

The Courts: Property Rules and Liability Rules

•Property rules specify the initial allocation of the entitlement (the right to cut trees or let them grow)

o In applying property rules, the court merely decides which right is preeminent and places an  injunction against violating that right.

• Liability rules can also correct inefficiencies by forcing those who cause the damage to bear the cost of  that damage.  

o Internalizing previously external costs causes profit maximizing decisions to be compatible with  efficiency.

o Cleaning oil spill and compensate fishermen for reduced catches.

Regulation (Fundamentals)

• Economic analysis of environmental policy

o Based on the idea that the harmful consequences of economic activities on the  environment constitute an externality.  

o But agents do not have an economic incentive to minimize the external costs of  pollution.  

o Environmental policies attempt to equalize this imbalance by raising the incentive for a  firm to minimize this externality

• Policy choices accomplish this in one of two general ways  

o Market-Based Approaches

• Financially internalizing the environmental costs so polluters make their own  decisions regarding their demand for environmental inputs

o Command and Control

• Imposing a limit on the level of environmental pollution

Absence of Property Rights  

• Property Rights

o The set of valid claims to a good or resource that permit the use and transfer of  ownership through sale.

o These rights are generally limited by law and/or social custom.

o In the context of environmental goods, it is unclear who “owns” rights.

▪ Economics says it is the absence of rights that matters, not who possesses them.  • China’s Pearl Delta Region

Coase Theorem

• Proper assignment of property rights

o Even if externalities are present, it will allow bargaining between parties such that  efficient solution results, regardless of who holds rights  

o Assumes costless transactions  

o Assumes damages are accessible and measurable

• Building the Model Refined Petroleum Market  

o Refineries use the river to release chemicals as an unintended byproduct of production ▪ Objective: to maximize profit

o Recreational users use the river for swimming and boating  

▪ Objective: to maximize utility

• Bargaining when Rights Belong to Refineries

o Recreational users are willing to pay (WTP) refineries for each unit of Q not produced ▪ Will pay up to the negative effect on utility (MEC)

o Refineries are willing to accept payment not to produce  

▪ Will accept payment greater than their loss in profit from contracting  

production (Mprofit)

• Bargaining When Rights Belong to Refineries  

o Initial point is Qc, since the refineries, who own the rights, would choose this point  o Recreational users:  

▪ Willing to offer a payment p

• P < (MSC - MPC), or p < MEC

o Refineries:  

▪ Willing to accept payment p

• P > (MPB - MPC), or p > Mprofit

*Bargaining Process graph*

• Bargaining should continue as long as

o (MSC - MPC) > p > (MPB - MPC) or  

o MEC > r > Mprofit •  

• At QC: Refineries’ Mprofit = 0, but MEC > 0, (distance XY)

o Since MEC > Mprofit, bargaining begins  

• Between QC and QE, same condition holds

• At QE: MEC = Mprofit, (distance WZ); output reductions beyond this point are infeasible, since  Mprofit > MEC

Bargaining When Rights Belong to Recreational Users

• Bargaining will proceed analogously  

• An efficient outcome can be realized without government intervention

• Limitations of the Coase Theorem

o Assumes costless transactions and measurable damages

o At minimum it must be the case that very few individuals are involved on each side of  the market

POLLUTION CONTROL: TARGETS

• In thinking about pollution policy, the economist is interested in two major questions:  1) How much pollution should there be?  

2) Given that some target level of emissions (pollution concentration) has been chosen, what is  the best method of achieving that level?  

• The question is: How much of a particular pollutant should be emitted annually at the national  level? Will you arrive to the same conclusion?

The concept of a pollution target

• Unless government takes the view that pollution levels should be decided entirely by free  market outcomes, a policy maker will, for a particular pollution problem, need to make a  decision about how much pollution should be permitted.

o Pollution targets may be based on what risk to health is deemed reasonable. o They may be based on what is acceptable to public opinion (Yellow Vests in France).  Policy is influenced very strongly by the interplay of pressure groups and interests.

*Maximum Permissible pollution levels graph*

 

• The target level of emissions (or pollution) resulting from any analysis depends on the modelling  framework employed, particularly its breadth  

o Breadth might refer to geographical or political scope (e.g. carbon emissions from US  alone or the rest of the world)

• It may also refer to the framework used:  

o Partial equilibrium or general equilibrium analysis

▪ A partial equilibrium approach looks at a single market (e.g. electricity) or  

activity, in isolation from the rest of the economic system

▪ A general equilibrium framework looks at the interactions of all the elements of  the entire economic system  

Modelling Pollution Mechanisms  

• Determine the level of pollution (pollution targets), using the criterion of economic efficiency.  o Economic activity generates emissions flows that impose pressures on the environment • The extent to which these pressures generate impacts that are associated with subsequent  damage depends on several things ⇒ e.g. the location of the environmental receptor, the  assimilative capacity of the receptor, people’s tastes, etc.

o Some proportion of the emission flows is quickly absorbed and transformed by the  environment into harmless forms  

o Some proportion of pressures will, in any time interval, remain unabsorbed or  untransformed (e.g. radioactive material)  

 

 

 *Damage impacts of two power plants*

Pollution flows, pollution stocks and pollution damage

• Flow-damage pollution (M)

• Occurs when damages result only from the flow of residuals; that is, the rate at which they are  being discharged into the environmental system

• By definition, for pure cases of flow-damage pollution (e.g. noise or light), the damage will  immediately drop to zero if emission flows stop

o Example: Noise: when the energy emission is terminated no residuals remain in  existence.

• Stock-damage pollution (A)

• Describes the case in which damages depend only on the stock of the pollutant in the relevant  environmental system at any point in time (e.g. concentration of CO2 in 1998)

• For a stock of the pollutant to accumulate, it is necessary that the residuals have a positive  lifespan and that emissions are being produced at a rate which exceeds the assimilative capacity  of the environment (e.g. heavy metals)  

o Extreme cases: Absorption capacity is zero. Metals such as mercury or lead accumulate  in soils, aquifers and biological stock (fish), and subsequently in the human body,  causing major damage to human health.

Economic Activity, Residual flows and environmental damage

 

Pollution flows, pollution stocks and pollution damage

At = aAt-1 + Mt

• a = 0 then At = Mt

• a = 1 then no assimilation -> irreversible growth in the stock.

Residual Flow and Environmental Damage

• Most important pollution problems have the attribute of a stock-damage pollution effect being  present  

• Besides the intuitive impact upon human health, agriculture, etc. pollution stocks may have an impact also on the assimilative capacity of the environment

• Nonetheless, from a regulatory perspective is difficult to regulate stocks, but it is often possible  only to act on flows  

• If M=pollution flow, A=pollution stock and D=pollution damage, then we have two damage  functions:  

– Flow-damage pollution: D = D(M)  

– Stock-damage pollution: D = D(A)

In sum

• Some emission flows will be quickly absorbed and transformed into harmless forms.

• Carrying capacities will be insufficient to deal with all wastes and in extreme cases the carrying  capacities will be zero.

• Physical and chemical processes take time to operate.  

• We can have environmental damage at the time of their emission, and may also, by accumulating as  pollution stocks, cause additional damage.

The efficient level of pollution emissions

• Pollution targets can be set using an economic efficiency criterion. Given that pollution is harmful, we  can argue that only a zero level of pollution is desirable.

• Zero pollution is not efficient, except in special circumstances. In what sense is pollution beneficial?

– Polluting activities also generate economic values

– Generally the marginal damage function starts from low values and is finite  

• Less pollution is preferred to more. But it may not be possible to keep “other things equal” as pollution  level is altered.

The efficient level of pollution emissions  

• If producers of goods and services act rationally, they will select private cost-minimizing techniques of  production, which generate harmful emissions as by-product (externality)  

• Production yields a benefit to the producer (polluter) and a damage to the pollute (i.e. the subject  which suffers from the externality)

•Damages can be thought of as a negative (adverse) externality  

– In many cases the externality happens to be a public bad, in that once it has been generated, no one  can be excluded form suffering its damaging effects

. The efficient level of pollution

With both benefits and costs, economic decisions about the appropriate level of pollution involve the  evaluation of a trade-off.  

• If a regulator requires that producers reduce these emissions, then emissions can be reduced if output  of the product is reduced.  

• Stricter pollution targets will not only generate benefits but will also generate costs.  

– The trade-off is optimized at the point where the marginal benefits arising from reduced pollution  damage fall to a level equal to the marginal benefit from avoided control costs.

– A simple static model can be used to identify the efficient level of a flow of a pollutant. – An efficient  level of emissions is the one that maximizes the net benefits from pollution.

– Recall the PMB=EMC condition for an efficient level of externality

Costs and Benefits of pollution  

• An efficient level of flow pollution M is the one for which net benefits are maximized. • This is equivalent to the outcome where the pollution externality is fully internalized.  – Net benefits ⇒ B(M) − D(M)  

– Condition ⇒ MB(M) = MD(M)

• Costs of pollution abatement.  

• Matters are less obvious with regard to the benefits of pollution.

Maximized Net Benefits

Efficient level of pollution

Pollution Control: Instruments

• Here we consider how an EPA could attain a predetermined pollution target by investigating the  instruments that could be used.

Pollution Policy

• Objectives of pollution policy:  

– Sustainability and ecological goals (e.g. minimum disruption to ecosystems, maintenance of  biodiversity)  

– Human health protection

– Public preferences

In thinking about pollution policy, the economist is interested in two major questions:  1. How much pollution should there be?

2. Given that some target level of emissions (or pollution concentration) has been chosen, what is the  best method of achieving that level?  

We focus on the second question, i.e. “Given that some target level of emissions (or pollution  concentration) has been chosen, what is the best method of achieving that level”?

Economic Theory contributes to both phases

Criteria for Selection of Pollution Control Instruments  

Cost efficiency and cost-effective pollution abatement instruments

• Suppose a list is available of all instruments which are capable of achieving some predetermined  pollution abatement target.

• If one particular instrument can attain that target at lower real cost than any other can then that  instrument is cost-effective.

– Strictly speaking, an instrument is cost-effective if its real resource cost is no greater than that of any  other instrument available.  

• Cost-effectiveness is clearly a desirable attribute of an instrument.

– Using a cost-effective instrument involves allocating the smallest amount of resources to pollution  control, conditional on a given target being achieved.  

– It has the minimum opportunity cost.  

– Hence, the use of cost-effective instruments is a prerequisite for achieving an economically efficient  allocation of resources.

Least-Cost Theorem of Pollution Control

• Let us explore some ramifications of the cost effectiveness criterion.  

• There will be many sources of an emission and so many potential abaters.  

• Main Question: How the overall target should be shared among the sources?

• The principle of cost efficiency provides a clear answer:  

• A necessary condition for abatement at least cost is that the marginal cost of abatement be equalized  over all abaters.  

• This result is known as the least-cost theorem of pollution control.

Least Cost Example  

• Consider a situation in which marginal abatement costs were not equalized.  

• For example, suppose that at present abatement levels two firms, A and B, have marginal abatements  costs of 60 and 100 respectively.  

• Clearly, is B did one less unit of abatement and A did one more (so that the total abatement is  unchanged) there would be a total cost reduction of 40.

• Cost savings will accrue for further switches in abatement effort from B to A as long as it is more  expensive for B to abate pollution at the margin than it is for A.

Suppose the government wishes to reduce the total emission of a particular pollutant from the current,  uncontrolled, level M = 90 to a target level M* = 50

– This implies that the abatement target is 40 units of emission per period.

– Emissions arise from the activities of two firms, A and B. Firm A currently emits 40 units and B emits  50 units.

– The quantity of pollution abatement by the ith firm is

Zi = Mi – M*i

• Suppose the total abatement cost functions of the two firms are:

Therefore, the marginal abatement cost functions are:

Marginal Abatement Cost Functions for the two firms

Marginal Abatement

Marginal Abatement Cost Functions for the two firms

Least Cost Example

Some Important Conclusion

A least-cost control regime implies that the marginal cost of abatement is equalized over all firms  undertaking pollution control.  

• A least-cost solution will in general not involve equal abatement effort by all polluters.  

• Where abatement costs differ, cost efficiency implies that relatively low-cost abaters will undertake  most of the total abatement effort, but not usually all of it

Solutions to Pollution

• Private solutions

– Assignment of property rights and bargaining (Coase Theorem)  

• Public Solutions  

– Direct Regulation (command and control; CAC)

– Market-based instruments  

• Pigouvian Taxes

• Pollution permits  

• Subsidies

Command and Control Instruments

The dominant method for reducing pollution in most countries has been the use of direct control over  polluters.  

– Definition of standards, obligations and prohibitions  

• This set of controls is commonly known as command and control instruments

• Command and control instruments can be designed to intervene at any stage of  production/consumption  

• Regulations may apply to emissions themselves, to the quantity of final production, to the production  techniques that are employed, or to the level and/or mix of productive inputs  

• It can consist on the ban of an input, the obligation to use a certain technology, the obligation to move  locate certain productive activities in a certain area, etc.

Non-transferable Emissions Licenses

• Suppose that the government is committed to attain some overall emissions target for a particular  pollutant  

• The government thus creates licenses (also known as permits or quotas) for that total allowable  quantity

• After adopting some criterion for apportioning licenses among the individual sources, the licenses are  distributed to sources of emissions (e.g. factories)  

• These licenses are non-transferable the licenses cannot be transferred (exchanged) between firms

• Each firm's initial allocation of pollution licenses sets the maximum amount of emissions that it is  allowed

The environmental target can be attained by license schemes only if polluters believe their action are  observed/monitored or if the penalties on polluters that pollute beyond the license are high relative to  the cost of abatement  

• License schemes have to be supported by costly monitoring systems and by sufficiently high penalties  for non-compliance  

• In presence of information asymmetries (marginal costs of each factory is observable only by the  factory itself and not by the government), nontransferable emissions licenses will not be cost efficient  

• Main issue: how to distribute licenses to factories?  

• No `continuous' price on pollution → price is zero up to the point in which the amount of licensed  emissions is reached, then becomes very large (and sometimes not even linked to the level of excess  pollution) beyond this point → little/no incentive to over-abate emissions

Minimum Technology Requirements

Command and control regulations that specify mandatory requirements for production processes or  specific equipment to be adopted  

• Minimum technology requirements are imposed upon potential polluters  

• Examples

– Best practicable means (BPM)  

– Best available technology (BAT)  

– Best available technology not entailing excessive cost (BATNEEC)  

– Catalytic converters for cars  

– Ban of incandescent light bulbs  

• In some variants of this approach, specific techniques are mandated, such as the use of fuel-gas  desulphurization equipment in power generation or minimum stack heights

Location Choices

• Pollution control objectives could be met by separating the location of people and pollution sources  

• This is only relevant where the effects of pollution generate local damages (e.g. ozone precursors,  while GHGs only entail a global uniform damage)

• Separation can occur ex ante or ex post  

– Ex ante zoning or planning control  

– Ex post think about displacing people from contaminated areas (e.g. Chernobyl)  

• Location decisions of this kind will not be appropriate when we are also concerned about the impact  of pollution on ecosystem services and not only about impacts on human health

Command and Control Assessment

• Attractive properties of command and control instruments  

– Certainty of outcome  

– Ability to get desired results very quickly  

– Little information is needed  

• Unattractive properties of command and control instruments  

– Likely to be cost-inefficient  

– They do not contain any mechanism that induce:  

– Equalization of marginal abatement costs across emitting sources  

– Equalization of marginal abatement costs across different programs (e.g. SO2 vs NOx abatement)  – Lack of dynamic incentives no premium for over-abatement

Valuing Environmental Changes

• Changes in these levels are a product of private actions, such as waste disposal or oil spills, or because  public actions, such as new environmental regulations (disruption of current systems).

Exxon Valdez → Set stage for Non-market Valuation

-providing monetary estimates of environmental damages

• Exxon Valdez oil tanker spilled 11 million gallons of crude oil off the Coast of Alaska on March 24th,  1989. Exxon Mobil accepted the liability for the damage caused by the liking oil.  

(1) The cost of cleaning up the spilled oil and restoring the site insofar as possible.  (2) Compensation for the damage caused to the local ecology.  

– 2.1 billion was spent on cleaning efforts, 303 million to compensate fishermen, punitive damages for  2.5 billion.  

• In the spring of 2010, the Deepwater Horizon, a BP well in the gulf of Mexico, exploded and began  spewing an Exxon Valdez oil spill every 4 to 5 days. More than 200 million gallons had been spread  through the Gulf of Mexico (20 times greater than the 1989 oil spill).

– 42.4 billion: Clean up costs, potential penalties, and damage claims

How can the economic damages from spills like these that caused substantial and economic harm be  calculated?  

– Thousands of birds have died from these spills. What are they “worth”?

Why value the environment?  

– Federal agencies rely on benefit-cost analysis for decision making.  

– These analyses frequently fail to incorporate important non-market values.

• Should humans place an economic value on the environment?

Many federal agencies depend on benefit  

– cost analysis for decision making. The goal is to choose economically desirable projects, given  limited budgets.  

– Natural resources damage assessments, such as for oil spills (National Oceanic and  Atmospheric Administration);

– For the designation of critical habitat under the Endangered Species Act (U.S. Fish and Wildlife  Service)

– Dam relicensing applications (The Federal Energy and Regulatory Commission) Valuation

We begin by exposing some of the special challenges posed by pollution control. The damages  by pollution can take many forms. The most obvious, is the effect on human health.  

• Assessing the magnitude of the damage requires:  

1. Identify the affected population.  

2. Estimate the physical relationship between pollutants and the damage to the affected  populations.  

3. Estimate the cost of mitigating the damage.  

4. Place a monetary value on the unmitigated physical damage.

Types of Value

• Economists decompose the total economic value conferred by resources into three main components:  – Use Value  

• The willingness to pay for direct use of the environmental resource  

– Option Value  

• The willingness to pay for the future ability to use the environment

– Passive-use Value (Non-consumptive Use Value)  

• Individuals’ willingness to pay to preserve a resource that he or she will never use ! TWP = UV + OV + NUV

Environmental Ethics

Biocentrism: Places the biologic world (primarily nonhumans) at the center of its value system.  – An important distinction made between instrumental value and intrinsic value. Instrumental value (Use Value) pertains to usefulness.

Intrinsic value (non-use value) does not pertains to usefulness. Something can be totally useless and  still have an intrinsic value.  

• Biocentrism is the philosophy that all living things have intrinsic value regardless of their instrumental  value.  

• One type of non-use value is a bequest value: future generations. A second type of non-use value is  called existence value

Valuation  

Classifying Valuation Methods

– Revealed preference method  

• Methods which are based on actual observable choices and from which actual resource values can be  directly inferred  

– Stated preference method

• Methods to elicit respondents’ willingness to pay when the value is not directly observable  • Each method includes both indirect and direct techniques.

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