Chapter 6: Externalities In Action

1 / 24
About This Presentation
Title:

Chapter 6: Externalities In Action

Description:

Chapter 6: Externalities In Action Outline Addressing externalities: should we focus on prices or on quantities? Understand why the answer is that it depends – PowerPoint PPT presentation

Number of Views:6
Avg rating:3.0/5.0
Slides: 25
Provided by: Pete3326
Learn more at: http://www.econ.wisc.edu

less

Transcript and Presenter's Notes

Title: Chapter 6: Externalities In Action


1
Chapter 6 Externalities In Action
  • Outline
  • Addressing externalities should we focus on
    prices or on quantities?
  • Understand why the answer is that it depends
  • Two problems
  • Some highlights from Chapter 6
  • Acid rain the problems with the 1970 Clean Air
    Act
  • Emissions trading
  • Global warming Kyoto and beyond
  • Smoking when is it a policy problem and when is
    it not?

2
A More Realistic Externality Example Acid Rain
  • Sulfur dioxide (SO2) and nitrogen oxides (NOX)
    released into the atmosphere, form sulfuric and
    nitric acids.
  • These acids may fall back to earth hundreds of
    miles away from their original source, known as
    acid rain.
  • Majority of acid rain in North America caused by
    SO2, much coming from coal-fired power plants
    concentrated in the Ohio River Valley.
  • Acid rain is a negative production externality.
    It
  • Makes lakes more acidic.
  • Erodes forests.
  • Causes damage to property (5 billion/year).
  • Reduces visibility.
  • Leads to adverse health outcomes

3
History of Acid Rain Regulation
  • 1970 Clean Air Act set maximum standards for
    various substances, including SO2.
  • It set New Source Performance Standards (NSPS)
    for any new power plant, forcing the plant to
    either reduce emissions or install scrubbers.
  • New plants, therefore, were made more expensive
    relative to older plants. Companies thus kept
    older, dirtier plants on line longer that they
    otherwise would.
  • Theres an analogy to imposing regulation on new
    autos.
  • Gruber calls this a consequence of partial
    policy reform.

4
History of Acid Rain Regulation
  • 1990 Clean Air Act Amendments mandated a
    reduction of more than 50 of the level of SO2
    nationwide, and included all plants.
  • It offered an SO2 allowance system that granted
    plants permits to emit SO2 in limited quantities,
    based on their historical fuel utilization.
  • Plants were allowed to buy, sell, or save their
    allowances.
  • The allowances involved very few restrictions
    trading could occur anywhere within the United
    States, with no approval or review, and the
    frequency and mechanism of trading were unlimited.

5
History of Acid Rain Regulation
  • The 1990 amendments and emissions trading drew
    opposition from two very diverse groups
  • Those opposed on economic grounds, like utilities
    and coal miners.
  • An industry study predicted the full cost of the
    regulations to be up to 7.4 billion, with a loss
    of up to 4 million jobs.
  • It was also opposed by environmentalists.
  • They opposed the 1990 amendments on the grounds
    that they created a market for vice and virtue.

6
History of Acid Rain Regulation
  • Estimates suggest that emissions trading
    significantly lowered the costs of the 1990
    amendments.
  • Over the 1995-2007 period, costs were lowered
    from 35 billion to 15 billion.
  • Thus, trading has worked to greatly improve the
    efficiency of regulation.
  • Even environmentalists are now more sympathetic
    to emissions trading, because it reduces economic
    opposition.
  • In less than a decade, emissions trading has
    gone from being a pariah among policymakers to
    being a star. -- Daniel Ellerman, expert on
    acid rain regulations

7
Has the Clean Air Act Been a Success?
  • The overall success of the Clean Air Act is much
    harder to determine.
  • The regulations were costly. In its first 15
    years, the Clean Air Act cost
  • 600,000 jobs.
  • 75 billion in output.
  • They did result in benefits, too.
  • Health improvements, such as reductions in infant
    mortality.
  • Burtraw, et al. (1997) estimate that the health
    benefits alone exceed the cost of reduction by a
    factor of seven, once the lower-cost trading
    regime was implemented.

8
A Second Externality Example Global Warming
  • The earth is heated by solar radiation that
    passes through our atmosphere and warms the
    earths surface.
  • A large portion of the heat is trapped by certain
    gasses in the earths atmosphere, which reflect
    the heat back toward the earth again.
  • This is known as the greenhouse effect.
  • The concentration of greenhouse gasses like
    carbon dioxide and methane has increased due to
    human activity.
  • Using fossil fuels like coal, oil, and natural
    gas produce carbon dioxide and contribute to this
    effect.

9
GLOBAL WARMING
  • The surface temperatures have increased by more
    than 1 degree Fahrenheit in the past 30 years.
  • Projections for the next 100 years suggest an
    unprecedented increase by as much as 6-10
    degrees.
  • Carbon emissions in Boston and Bangkok have the
    same effect on the global environment.
  • The stock, not the flow, of carbon dioxide cause
    the warming. Thus, it takes a long time to undo
    the damage.
  • Global warming is a thus a complicated
    externality involving many nations and many
    generations of emitters.

10
The U.S. is currently responsible for nearly 25
of the planets carbon dioxide emissions.
Developing counties like China and India emit
large quantities of greenhouse gasses.
Japan contributes only 5 of annual emissions.
11
The Kyoto Treaty
  • The goal of the Kyoto treaty in 1997 was to
    reduce the emissions of greenhouse gasses to 5
    below their 1990 levels.
  • United States and Russia have not signed on many
    other of the 38 industrialized nations have,
    however.
  • For the United States, the Kyoto treaty would
  • Mean reducing emissions in 2010 by roughly 30
  • With a present discounted cost of
    1,100,000,000,000 (1.1 trillion)
  • The United States would bear 90 of the total
    world cost, even though it contributes only 25
    of annual greenhouse gas emissions.

12
Can Trading Make Kyoto More Cost-Effective?
  • Kyoto treaty introduced international emissions
    trading.
  • Under the Kyoto treaty, the industrialized
    signatories are allowed to trade emissions rights
    among themselves, as long as the total emissions
    goals are met.
  • There are tremendous differences across developed
    nations in terms of meeting these goals, for two
    reasons
  • Slow growth in some countries Relatively easy
    for a country like Russia to meet its goal.
    Estimates suggest that emissions trading (say,
    from Russia to United States) could lower the
    cost of the treaty by 75.
  • Environmentally conscious growth Other
    countries, like Japan, tend to use more gas and
    nuclear-powered production.
  • Figure 3 shows the benefits of international
    emissions trading (the readings for today give an
    update from the Montreal, the site of the most
    recent international climate change meetings).

13
Yet the treaty calls for the U.S. to reduce
emissions a lot.
It is fairly expensive for the U.S. to reduce its
emissions.
It is easier for Russia and others to reduce
their emissions.
And the requirements are lower, too.
Price of carbon reduction
SUS
The total cost to the U.S. is 440x210.
SR
ST
210
The overall cost, with emissions trading, is 32
billion.
With emissions trading, the supply curve is
summed horizontally.
The cost of worldwide emission reduction is 50
per ton with ST.
The total cost to Russia and others is 190x20.
50
The U.S. buys 400 permits (440-40).
The overall cost, with no emissions trading, is
96 billion.
20
Carbon Reduction (millions of metric tons)
0
630
440
190
590
40
14
A Third Externality Example The Economics of
Smoking
  • Smoking causes more than 440,000 deaths each
    year, four times as much as AIDS, motor vehicle
    accidents, homicide, and suicide combined.
  • What is the role for government intervention in
    the case of a decision like smoking? Several
    possible arguments
  • Smoking is bad for you.
  • Smoking is addictive.
  • It generates negative externalities to the health
    system, workplace, and fire departments.
  • It generates positive externalities to the Social
    Security and Medicare system.
  • It creates negative externalities to other family
    members through secondhand smoke.

15
THE ECONOMICS OF SMOKING
  • Smoking is bad for you.
  • Smoker lives about 6 fewer years than a
    nonsmoker.
  • A year of life is valued by economists at about
    200,000.
  • In standard utility-maximization, any damage
    individuals do to themselves from dangerous
    activities results from a rational tradeoff of
    benefits against potential costs.
  • Perhaps a rationalization can be given because
    young people make decisions to smoke when they
    are not capable of sensibly assessing the
    benefits and costs of their decisions
  • Or cigarettes are so additive that people dont
    understand they cant quit (or have a very hard
    time quitting).

16
THE ECONOMICS OF SMOKING
  • Smoking is addictive.
  • Rational addicts understand that each cigarette
    that they smoke today increases their addiction.
  • Smokers consider not only the cost of todays
    pack of cigarettes, but the cost of all
    additional future packs that will now be
    purchased because their addiction is deepened.
  • Smokers also understand that smoking doesnt just
    reduce health through the current cigarette, but
    all future cigarettes that will be consumed
    because of the addiction.
  • With this model, smoking remains a rational
    choice.

17
The Externalities of Smoking
  • Smoking generates negative externalities due to
    higher health costs.
  • Smoking-related disease increases U.S. medical
    care costs by 75 billion annually, 5 of the
    total.
  • If insurance companies can make actuarial
    adjustments, they simply charge smokers higher
    rates.
  • Such adjustments internalize the medical cost
    externality from smoking. In a simple model,
    there are no health externalities because smokers
    pay for the high medical costs through higher
    premiums.

18
The Externalities of Smoking
  • In fact, actuarial adjustments are often not made
    with employer health insurance.
  • In this case, the externality is financial, not
    physical. This is an externality because the
    social marginal benefit from an individuals
    cigarette consumption is below the private
    marginal benefitthe individuals coworkers have
    to pay higher premiums.
  • In addition to higher health costs to the private
    sector, individuals who receive government
    insurance exert a negative externality onto
    taxpayers.
  • The same is true of the uninsured (smokers and
    non-smokers alike)they exert negative
    externalities onto medical providers, who pass
    along the costs to consumers.

19
The Economics of Smoking
  • Smoking generates negative externalities due to
    lower workplace productivity and more frequent
    absences.
  • Firms may be able to adjust wages to compensate
    for this type of problem.
  • If workers wages adjust to compensate for their
    lower expected productivity, then the externality
    is internalized, akin to the adjustments in
    health premiums.

20
The Economics of Smoking
  • Smoking generates negative externalities due to
    fires, mostly due to falling asleep with a
    burning cigarette.
  • To the extent the smoker only damages himself and
    his own property, there is not an externality.
    But if the fire spreads to other properties,
    there is an externality.
  • Also costs to fire departments and insurance
    companies that may not be fully internalized.

21
The Externalities of Smoking
  • Smoking generates positive externalities to
    taxpayers due to the early deaths of smokers and
    lower payouts for some social insurance programs.
  • Often contribute payroll tax for Social Security
    and Medicare during working life, but smokers may
    not be alive to collect benefits when they are
    elderly.

22
The Economics of Smoking
  • Smoking generates negative externalities (mostly
    to other family members) through secondhand
    smoke.
  • Considerable medical uncertainty about the
    damages done from this.
  • Moreover, if the smoker maximizes family utility
    rather than individual utility, he/she rationally
    trades off the benefits to himself/herself versus
    the harm to his/her family.
  • Evidence suggest family utility maximization is
    incomplete, however.

23
The Economics of Smoking
  • Taken together, the external costs of smoking are
    roughly 40 per pack of cigarettes in 2003
    dollars.
  • Estimates of external costs of secondhand smoke
    vary widely, from 1 to 1.16 per pack.
  • The average federal plus state cigarette tax is
    over 1 per pack.

24
Should We Care Only About Externalities, or Do
Internalities Matter Also?
  • Traditional economics approach cares only about
    externalities that smokers impose on others.
  • Model ignores some key features of the smoking
    decision that may motivate government
    intervention.
  • Youth smoking decisions
  • Inability of adults to quit
  • Maybe policymakers should decide that people are
    unable to do what is best for them, and
    consequently policy should try to influence
    choices. This, of course, is a slippery slope.
  • Information/outreach campaignsthese have reduced
    the smoking rate a lot over the last 30 years.
  • Reducing access to cigarettes for teenagers.
  • Taxationelasticity of demand for cigarettes is
    around -0.5, and higher for youth smokers.
Write a Comment
User Comments (0)