Title: Economic Solutions to Environmental Problems The Market Approach
1Economic Solutions to Environmental Problems The
Market Approach
2Overview
- Market approach refers to incentive-based policy
that encourages conservative practices or
pollution reduction strategies - Difference between market approach and
command-and-control approach is how each approach
attempts to achieve its objectives - Types of Market Instruments
- Pollution charge
- Subsidies
- Deposit/refund systems
- Pollution permit trading systems
3Pollution Charges
4Pollution Charge
- Fee that varies with amount of pollutants
released - Based on Polluter-Pays Principle
- Types of pollution charges
- Effluent/emission fees
- Product charge
- User charge
- Administrative charge
5Product Charge
- Fee added to price of pollution-generating
product, which generates negative externality - Impose product charge as per unit tax on product,
e.g., gas tax - How does the tax on gasoline in the US compare
with that of other nations? - If the tax equals the marginal external cost
(MEC) at QE, it is called a Pigouvian tax
6Selected International Gasoline Tax Rates
Nation Tax Rate of Price (2004)
United States 20
U.K. 73
France 71
Italy 65
Japan 50
Spain 59
Source International Energy Agency, August 13,
2004
7Modeling a Pigouvian Tax
MSC MPC MEC
MPCt
MPC
a
Amount of tax
b
MPB MSB
0
Q of gasoline
QE
QC
8Assessing the Model
- In theory, achieves an efficient outcome
- In practice, difficult to identify the value of
MEC at QE - Allows only for an output reduction to reduce
pollution
9Emission (Effluent) Charge
- A fee imposed directly on the discharge of
pollution - Assigns a price to pollution
- Typically implemented through a tax
10Model Single Polluter Case
- Government sets an abatement standard at AST
- Policy options to polluter are
- Abate up to AST and incur those costs OR
- Pay a constant per unit tax, t, on any abatement
less than AST - Total Tax t(AST - AO)
- where AO is actual abatement level
- Marginal Tax (MT) t
- Because t is constant, t MT
- Firm will choose the least-cost option the
marginal tax (MT) or the marginal abatement cost
(MAC)
11Modeling Emission ChargeSingle Polluter
Firm abates up to Ao since MAC lt MT firm pays
tax between AO and AST, since MAC gt MT in that
range
MAC
0aAO cost to abate AO AOabAST tax on
pollution not abated up to AST
c
a
b
MT
t
0
AO
AST
Abatement (A)
12Model Multiple Polluter Case
- To facilitate comparison, we use the same model
as in the uniform standard case - Assumptions
- 2 polluting sources in some region
- Each generates 10 units of pollution
- Government sets emissions limit for region as 10
units, which implies AST 10 - Policy To achieve AST, government imposes an
emission charge as a unit tax (t) of 5
13Model Multiple Polluter Case
- Each firm responds as in the single polluter case
- Abates as long as MAC lt MT
- Pays emission charge when MAC gt MT
- Polluter 1 TAC1 1.25(A1)2 MAC1
2.5(A1) - where A1 is pollution abated by Polluter 1
- Polluter 2 TAC2 0.3125(A2)2 MAC2
0.625(A2) - where A2 is pollution abated by Polluter 2
- Find each firms abatement level. Then, find each
firms total abatement costs (TAC) and tax
payment at that level. Support with a graph.
14Solution
- Polluter 1
- Abates up to the point where MAC1 MT,
- Set 2.5(A1) 5, or A1 2
- Incurs TAC1 1.25(2)2 5
- Incurs Total Tax 5(10 - 2) 40
- Polluter 2
- Abates up to point where MAC2 MT
- Set 0.625(A2) 5, or A2 8
- Incurs TAC2 0.3125(8)2 20
- Incurs Total Tax 5(10 - 8) 10
15Modeling An Emission ChargeMultiple Polluter
MAC1
MAC2
Total Abatement Level 10 As TAC1 TAC2 25
(right triangles) Total Tax Payments 50
(rectangles)
25.00
MAC1
6.25
MT 5.00
MT 5.00
MAC2
0 10
10 0
2
Polluter 1s Abatement
8
Polluter 2s Abatement
16Assessing the Model (pros)
- Abatement standard is met
- Generates 40 in tax revenues from high-cost
abater and 10 from low-cost abater - Low-cost abaters do most of cleaning up
- Cost-effective solution is obtained
- MACs are equal at 5 tax rate
- Combined TAC of 25 is lower than 39.06 under
command-and-control with a uniform standard
17Assessing the Model (cons)
- Tax authority will not know where MACs are equal
- Will have to adjust rate until objective achieved
- Monitoring costs potentially higher
- Firms might evade tax by illegally disposing
pollutants - Distributional implications
- Consumers may pay higher prices due to tax
- Job losses may result from polluter paying new
taxes and/or changing technology to abate
18Pollution Charges in Practice
- Internationally, the pollution charge is the most
commonly used market-based instrument - Some countries use effluent charges to control
the noise pollution generated by aircraft - Others levy charges on products such as motor
vehicles, pesticides, fertilizers, batteries and
gasoline
19Environmental Subsidies
20Environmental Subsidies
- Two major types of subsidies
- Abatement equipment subsidies
- Pollution reduction subsidies
21Abatement Equipment Subsidy
- Defined as a payment aimed at lowering the cost
of abatement technology - Goal is to internalize the positive externality
associated with the consumption of abatement
activities - If the subsidy (s) equals the marginal external
benefit (MEB) at QE, it achieves an efficient
equilibrium and is called a Pigouvian subsidy
22Pigouvian SubsidyMarket for Scrubbers
23Assessing the Model
- It is difficult to measure the MEB
- May bias polluters decisions about how best to
abate
24Pollution Reduction Subsidy
- To implement, government pays the polluter a
subsidy (s) for every unit of pollution abated
below some pre-established level ZST - Per unit subsidy s(ZST - ZO), where ZO is the
actual level of pollution - Analogous to an emission charge
25Assessing the Model
- Might be less disruptive than an equipment
subsidy - Can have the perverse effect of elevating
pollution levels in the aggregate since the
subsidy lowers unit costs and raises profit,
encouraging entry
26Subsidies in Practice
- Environmental subsidies typically are implemented
as grants, low-interest loans, tax credits or
exemptions, and rebates - Many countries around the world use these
instruments, including Austria, Finland, Japan,
and Turkey - In the U.S., common uses include federal funding
to build publicly-owned treatment works and
subsidies to encourage the development of cleaner
fuels and low-emission vehicles
27Deposit-Refund Systems
28Deposit/Refund Systems
- A deposit/refund system is a market instrument
that imposes an up-front charge to pay for
potential damages and refunds it for returning a
product for proper disposal or recycling - Targets the potential vs. actual polluter
- The deposit is intended to capture the MEC of
improper waste disposal (IW) in advance - Preventive vs. ameliorative
29Modeling Deposit/Refund SystemIW disposal market
- MECIW health damages aesthetic impairment from
litter, trash accumulation, etc. - MPCIW costs to disposer (e.g., trash
receptacles, collection fees, plus forgone
revenue from not recycling) - MSCIW MPCIW MECIW
- MPBIW demand for improper disposal
- Assume MEBIW 0, so MPBIW MSBIW
30Deposit-Refund Model
Deposit converts of overall waste disposal,
measured by (QIW - QE), from improper methods to
proper
MSCIW
MPCIW Deposit
MPCIW
a
DepositMEC at Qe
b
MPBIW MSBIW
QE
QIW
Improper Waste Disposal ()
0
100
Proper Waste Disposal ()
0
100
31Assessing the Model
- Promotes responsible behavior
- Requires minimal supervision by government
- Can help slow the use of virgin raw materials by
improving availability of recycled materials
32Deposit/Refund Systems in Practice
- Deposit/refund systems are used worldwide
- Many nations use these systems to encourage
proper disposal of beverage containers - In the US, 11 states have bottle bills
- Other applications include systems used to
promote responsible disposal of used tires, car
hulks, and lead-acid batteries
33Pollution Permit Trading Systems
34Pollution Permit Trading Systems
- A pollution permit trading system establishes a
market for rights to pollute by issuing tradeable
pollution credits or allowances - Credits are issued for emitting below a standard
- Allowances indicate how much can be released
- Two components of the system are
- Fixed number of permits is issued based on an
acceptable level of pollution set by government - The permits are marketable
- Bargaining gives rise to a market for pollution
rights
35How Permit Trading Works
- There is an incentive to trade as long as
polluters face different MAC levels - Suppose a firm has 50 permits but normally emits
75 units of SO2. What must it do? - Answer
- Abate 25 units of emissions OR
- Buy 25 permits from another producer
- Which option will the firm choose?
- Answer
- Whichever option is cheaper
36Result
- Low-cost abaters will clean up pollution and sell
excess permits to other firms - They will sell at any P higher than their MAC
- High-cost abaters will buy permits rather than
abate - They will buy at any P lower than their MAC
- Trading will continue until the incentive to do
so no longer exists, at which point, the
cost-effective solution is obtained, i.e., the
MACs across firms are equal
37Assessing the Model
- Trading establishes the price of a right to
pollute without government trying to search for
a price - No tax revenues are generated
- Trading system is flexible
- Note that an emissions standard can be adjusted
by changing the number of permits issued
38Pollution Trading Systems in Practice
- International examples
- Trading of greenhouse gas allowances are part of
the Kyoto Protocol, an international accord aimed
at global warming - Canada has a trading program for ozone-depleters
- Denmark has one for carbon dioxide emissions
- Most of the evolution of trading is occurring in
the U.S. - An important example is the establishment of an
allowance-based trading program to control sulfur
dioxide emissions under the Clean Air Act
Amendments of 1990