Micro-Economie Topic 10 Environmental Protection

1. Micro-Economie Topic 10Environmental Protection • Externalities and Public Goods/Bads • Pollution – the bargaining solution • Policy alternatives for pollution control • Who pays for pollution control? • Is pollution control bad for business?

2. An externality occurs when an activity generates unintended effects on others for which no payment or compensation is made. Externalities arise because of the absence of private property rights – if they existed payment/compensation would occur. They are an example of market failure. Externalities may be beneficial or harmful In the absence of corrective policy, the level of an activity that gives rise to a harmful/beneficial externality will be too high/low. External effects often have the characteristics of public goods/bads.

3. Public goods/bads have two characteristics • Non-rivalry – consumption by one agent does not reduce the amount available to others • Non-excludability – if provided for one agent, others cannot be excluded from consumption • Examples of public goods – national defence, lighthouses • Examples of public bads – air pollution • Because of non-rivalry and non excludability, the market cannot supply the right amount of public goods/bads – the free rider problem

4. All of these externalities are non-rivalous and non-excludable

5. Bargaining – The Coasian Solution MCN MBT Figure 13.6 a c b d Noise 2 1 3

6. Limitations to the Bargaining Solution to Pollution Problems • Transactions Costs • Large numbers of generators and/or sufferers • Linkage identification 2. The effect is Public a) non-excludable b) non-rival

7. Pollution Control: Two Questions for Public Policy • How much pollution should be allowed? What is the policy objective? • 2. How to affect polluters’ behaviour so as to bring about the desired level of pollution? What policy instrument to use? MC(P) =MB(A) MB(P)=MC(A) Although the Coase analysis is not very helpful in regard to Q2, it does provide the answer to Q1. The efficient level of pollution is where marginal cost equals marginal benefit. P* Pollution,P Abatement,A A*

8. There are 3 classes of Instrument for controlling pollution • Command and Control • a. Limits on permitted discharges • b. Regulation of process and/or equipment • 2. Discharge taxation, also known as emissions taxation • 3. Tradeable discharge permits, also marketable emissions permits • Historically, class 1 has been the most popular with legislators. • But, economists favour classes 2 and 3 on the grounds that they involve lower costs.

9. Taxation of a negative externality Figure 13.5 SMC=PMC+EMC PMC P2 P1 EMC SMB+D Q, P Q2 Q1

10. With uniform taxation across discharge sources, the overall reduction is achieved at least cost MNPB1 MNPB2 a b t t P1 P2 P2t P2* P1t P1* MNPB is Marginal Net Private Benefit = MPB – MPC No tax - Profit maximised where MNPB = 0 With tax – Profit maximised where MNPB = t Total Cost of pollution reduction = aP1*P1t + bP2*P2t There is no re-allocation of pollution reduction as between the two firms that can reduce the total cost

11. There is a problem with emissions taxation – if the firms’ MNPB(P) functions are not known, it is not possible to calculate the tax rate that will bring about the desired overall reduction in pollution. Whatever reduction is achieved will be brought about at least cost, but it could be too big or too small. Tradeable permits avoid this problem. Since the quantity of permits issued is equal to the desired level of total emissions, assuming compliance, the achieved reduction is that intended. Tradeable permits are dependable, as well as least cost. They have the least cost property because with a single market price per permit, all firms move to where their MNPB = permit price, and the situation is as in the previous slide. If the permits are initially issued free, there is no revenue arising, as there is with taxation.

12. Who bears the cost of pollution control? P Figure 13.7 S2 t S1 P2 P1 P3 t D Q Q2 Q1

13. Is pollution control necessarily bad for business? • It may promote technological innovation that reduces costs • Reputation effects • Niche marketing – environmentally concerned customers • First mover effects – international trade • Environmental tax revenues can be used to reduce other taxes on business

14. Team Tasks 10 • What is the optimal level of pollution? • If an emissions tax is imposed, does the polluter pay? • As CEO of a chemical company, should you oppose the introduction of legislation to reduce environmental pollution by the chemical industry?