Market Failure

1. Market Failure Fixing inefficiency without creating more

2. One Idea • The budget also includes revenue from a national cap-and-trade systemfor greenhouse gas emissions, which would come from auctioning off emissions permits to industries. The climate program would generate nearly $650 billion between 2012 and 2019, according to Obama's proposal.About $80 billion of the climate revenues would go toward Obama's proposed middle-class tax cut each year beginning in 2012, the draft says, and the government would spend $15 billion per year on "clean" energy technologies. In his address to Congress on Tuesday, Obama said those technologies would include wind power, solar power, advanced biofuels, "clean coal" and more efficient cars and trucks. • February 26, 2009 Obama's draft budget projects cap-and-trade revenue

3. Efficient Allocation • Marginal Benefit • A measure of the benefits of the next unit of the activity • Marginal Cost • A measure of the costs of the next unit of the activity • MB=MC • efficiency

4. Marginal Benefits • Who gains from some allocation of resources? • How much do they gain? • What are the various dimensions of that gain?

5. Marginal Costs • Who pays for some allocation of resources? • How much do they give up? • What are the various dimensions of the costs?

6. The Concept is Simple • Find the level of activity where MB=MC • Zero profits drive resources • Marginal Revenue Products allocate revenues

7. Adding Dimensions • When we talk of the consumer’s location in a spatial sense, we can equally talk of the country in which the consumer is located, the time of day, month or year at which the consumer would prefer to purchase the commodity, or the consumer’s most preferred product variety in the sense of Lancaster. • Greenhut, Norman and Hung (1987)

8. Private Property? • Trespass • Nuisance • Are individuals islands?

9. Externalities • An externality is an effect of a purchase or use decision by one set of parties on others who did not have a choice and whose interests were not taken into account.

10. Classic example of a negative externality • Pollution, generated by some productive enterprise, and affecting others who had no choice and were probably not taken into account.

11. An example of a positive externality • The effect of a well-educated labor force on the productivity of a company • The result is public education – or that is the argument.

12. Graph Time

13. Coase (1960), • The spawn of which lead in two distinct directions. • The so-called Coase Theorem, based on the assumption of zero transaction costs, led directly and indirectly to the private property rights school of thought: individual actions can lead to efficient allocations as long as property rights are designated. • Stigler first coined the term “Coase Theorem” to explain the theory of internalizing externalities.

14. Coase’s real purpose was quite the opposite. • “The world of zero transaction costs has often been described as a Coasian world. Nothing could be further from the truth. It is the world of modern economic theory, one which I was hoping to persuade economists to leave.” (Coase, 1988, 174, emphasis added.).

15. He realized the importance of transaction costs. • When transaction costs are relevant, as is the case in most of the currently appropriate areas of discussion, Coase argued against the private solution. • The recognition of transaction costs not only alters consumption behavior, but also changes our way of knowing and forms of social organization by requiring non-market institutions to intercede in the decision processes.

16. Internalizing the Externalities • Graph again • System benefits

17. APS January 2010 • Cost of net electricity • Basic service charge $1.82 • Delivery service charge $3.35 • Environmental benefits surcharge $0.86 • Federal environmental improvement surcharge $0.02 • Competition rules compliance charge $0.03 • System benefits charge $0.19 • Power supply adjustment -$0.10 • Metering $2.60 • Meter reading $1.79 • Billing $2.02 • Generation of electricity $4.46 • Transmission and ancillary services $0.49 • Transmission cost adjustment $0.21 • Interim rate surcharge $0.07 • Cost of electricity you used 17.81 Literally Nickel and Diming

18. Taxes and fees • Regulatory assessment $0.05 • State sales tax $1.00 • County sales tax $0.21 • City sales tax $0.00 • Franchise fee $0.00 • Cost of electricity with taxes and fees $19.07 • Total charges for electricity services $19.07

19. Amount of electricity from APS • Meter reading on Jan 20 7794 • Meter reading on Dec 21 7484 • Total electricity from APS, in kWh 310 • Amount of electricity credited • Meter reading on Jan 20 8629 • Meter reading on Dec 21 8413 • Total electricity credited, in kWh 216 • Last month's kWh credit 0 • Net electricity • Electricity from APS, in kWh 310 • Minus electricity credited, in kWh 216 • Minus last month's kWh credit 0 • Net electricity, in kWh 94

20. A Simple Idea • Collect: We must use mechanisms to establish a price for emissions and collect this pollution-based revenue to help fund a smart transition to a low-emission economy. • Use elasticities to estimate the variation between the private market price and the social equilibrium price. • Forecasting tools

21. Cap, Collect, and Invest • “Invest: We must invest this revenue to accelerate research, widespread commercialization, and adoption of new clean energy and efficiency technologies; ensure that American workers and communities are buffered against near-term price increases; and invest in measures to prepare for and adapt to the effects of global warming that are already locked into the system, both here in the United States and in vulnerable, developing countries.” • http://www.americanprogress.org/issues/2008/06/pdf/auction_revenue.pdf

22. Cap and Trade • The goal: To steadily reduce carbon dioxide and other greenhouse gas emissions from economic activity as part of a larger plan for curbing global warming.

23. The cap: • Each large-scale emitter, or company, will have a limit on the amount of greenhouse gas that it can emit. The firm must have an “emissions permit” for every ton of carbon dioxide it releases into the atmosphere. These permits set an enforceable limit, or cap, on the amount of greenhouse gas pollution that is released. Over time, the limits become stricter, allowing less and less pollution, until the ultimate reduction goal is met.

24. The trade: • It will be relatively cheaper or easier for some companies to reduce their emissions below their required limit than others. These more efficient companies, who emit less than their allowance, can sell their extra permits to companies that are not able to make reductions as easily. This creates a system that guarantees a set level of overall reductions, while rewarding the most efficient companies and ensuring that the cap can be met at the lowest possible cost to the economy.

25. The profits: • If the federal government auctions the emissions permits to the companies required to reduce their emissions, it would create a large and dependable revenue stream. These financial resources could be used to achieve critical public policy objectives related to climate change mitigation and economic development. The federal government can also choose to “grandfather” allowances to the polluting firms by handing them out free based on historic or projected emissions. This would give the most benefits to those companies with higher baseline emissions that have historically done the least to reduce their pollution.

26. From: • Investing in a Green Economy; Using Cap-and-Trade Auction Revenue to Help American Families and Spur Clean Energy Innovation) • http://www.americanprogress.org/issues/2008/06/pdf/auction_revenue.pdf

27. http://www.state.mn.us/mn/externalDocs/Commerce/Governance_Options_for_Carbon_Cap__Trade_Revenue_022009040546_GovernanceOptions_CapAndTrade.pdfhttp://www.state.mn.us/mn/externalDocs/Commerce/Governance_Options_for_Carbon_Cap__Trade_Revenue_022009040546_GovernanceOptions_CapAndTrade.pdf