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Economic Solutions to Environmental Problems: The Market Approach

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Chapter 5 Economic Solutions to Environmental Problems: The Market Approach Pollution Trading Systems in Practice Most of the evolution of trading is occurring in U.S. – PowerPoint PPT presentation

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Title: Economic Solutions to Environmental Problems: The Market Approach


1
Economic Solutions to Environmental Problems The
Market Approach
  • Chapter 5

2
Overview
  • Market approach refers to incentive-based policy
    that encourages conservative practices or
    pollution reduction strategies
  • Types of Market Instruments
  • Pollution charges
  • Subsidies
  • Deposit/refund systems
  • Pollution permit trading systems

3
1. Pollution Charges
  • Fees based on Polluter-Pays Principle (polluter
    should bear costs of control measures)
  • Types of pollution charges
  • Product charge
  • Emission/Effluent charge

4
(1) Product Charge
  • A fee added to price of pollution-generating
    ___________, which generates negative externality
  • Impose product charge as per unit tax on product,
    e.g., gas tax
  • If the tax equals the marginal external cost
    (MEC) at QE, it is called a _________ _____
  • How does the tax on gasoline in the US compare
    with that of other nations?

5
Selected International Gasoline Tax Rates
Nation Tax Rate of Price (2008)
United States 18.5
U.K. 67.8
France 67.4
Germany 70.3
Japan 45.8
Spain 56.0
Source International Energy Agency, November,
2008
6
Modeling a Pigouvian Tax

MSC MPC MEC
MPCt
MPC
a
Amount of tax
b
MPB MSB
0
Q of gasoline
QE
QC
7
Making sellers pay a tax on each unit they sell
is equivalent to an increase in the cost of
producing each unit. Anything that increases
production costs causes the S curve to shift up
in order for sellers to be willing to supply the
same quantity as before, they must receive a
higher price to compensate them for the increase
in their costs.
8
By setting the unit tax equal to the MEC at QE,
the MPC curve shifts up to MPCt. Equilibrium
output is then determined by MPCt and MSB, which
is QE.
9
Assessing 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

10
(2) Emission/Effluent Charge
  • A fee imposed directly on the discharge of
    _____________
  • Typically implemented through a tax

11
Model Single Polluter Case
  • Government sets an abatement standard at AST
  • A0 is actual abatement level.
  • Policy options to polluter are
  • Abate up to AST and incur those costs, or
  • Pay a constant per unit tax, t (also called
    marginal tax, MT), on any abatement less than AST

12
Modeling Emission ChargeSingle Polluter

MAC
Firm abates up to A0 since MAC lt MT firm pays
tax between A0 and AST, since MAC gt MT
c
a
b
MT
t
0
AST
A0
Abatement (A)
13
Pollution Charges in Practice
  • Internationally, the pollution charge is the most
    commonly used market-based instrument
  • Australia, Bulgaria, France, and Japan, use fees
    or taxes to control noise pollution generated by
    aircraft
  • France, Mexico, and Poland are among the nations
    using effluent charges to protect water
    resources.
  • Others levy charges on products such as
    batteries, tires, lubricant oil, packaging,
    paint, paint containers, and gasoline

14
2. Environmental Subsidies
  • Two major types of subsidies
  • Abatement equipment subsidies
  • Pollution reduction subsidies

15
(1) Abatement Equipment Subsidy
  • 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 equals the marginal external
    benefit (MEB) at QE, it achieves an efficient
    equilibrium and is called a __________________

16
Pigouvian SubsidyMarket for Scrubbers
Coal-burning power plants buy scrubbers scrubber
manufacturers sell scrubbers

( millions)
MSC
K
PE 175
Subsidy 14 million
PC 170
MSB
L
MPBS
PE s 161
MPB
0
QC 200
QE 210
Q of scrubbers
17
  • In a competitive market, too few scrubbers are
    exchanged at too low a price because the MEB of a
    cleaner environment are not recognized by the
    market participants.

18
(2) Pollution Reduction Subsidy
FYI
  • 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, total subsidy s(ZST -
    ZO), where ZO is the actual level of pollution
  • Analogous to an emission charge

19
Subsidies in Practice
FYI
  • 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 Belgium, Denmark, 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

20
3. Deposit/Refund Systems
  • 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
  • The deposit is intended to capture the MEC of
    improper waste disposal (IW) in advance

21
Modeling Deposit/Refund System improper waste
(IW) 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

FYI
22
Deposit-Refund Model
FYI
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
23
Assessing 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

24
Deposit/Refund Systems in Practice
  • Deposit/refund systems are used worldwide
  • Many nations use these systems to encourage
    proper disposal of beverage containers in the
    U.S., 11 states have bottle bills
  • Other applications include systems used to
    promote responsible disposal of used tires, car
    hulks, and lead-acid batteries

25
4. Pollution Permit Trading Systems
  • A pollution permit trading system establishes a
    market for rights to pollute by issuing _________
    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

26
How Permit Trading Works
  • There is an incentive to trade as long as
    polluters face different ________ 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

27
Result
  • Low-cost abaters will clean up pollution and sell
    excess permits to other firms
  • They will _____ at any P _____ than their MAC
  • High-cost abaters will buy permits rather than
    abate
  • They will _____ at any P _____ 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 _________

28
An Example (Ch4slide 20)
  • 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

29
Round 1 Government issues 5 permits to each
polluter
  • Polluter 1 Current pollution level 10 units
  • of permit held
    5
  • abatement required 5
  • MAC1 2.5(A1)2.5( __ ) 12.50
  • TAC1 1.25(A1)21.25( __) 2 31.25
  • Polluter 2 Current pollution level 10 units
  • of permit held
    5
  • abatement required 5
  • MAC2 0.625(A2)0.625( ___) 3.125
  • TAC2 0.3125(A2)20.3125( ___) 2 7.81

30
Round 2 Polluter 1 purchases 1 permit (8.00)
from polluter 2
  • Polluter 1 Current pollution level 10 units
  • of permit held
    6
  • abatement required 4
  • MAC1 2.5(A1)2.5( ___) 10.00
  • TAC1 1.25(A1)21.25(___) 2 20.00
  • (cost of 1 permit purchased8.00)
  • Polluter 2 Current pollution level 10 units
  • of permit held
    4
  • abatement required 6
  • MAC2 0.625(A2)0.625(___) 3.75
  • TAC2 0.3125(A2)20.3125(___) 2 11.25
  • (revenue from 1 permit sold8.00)

31
Final round Polluter 1 purchases 3 permits (8
7 5) from polluter 2 MAC1 MAC2
  • Polluter 1 Current pollution level 10 units
  • of permit held
    8
  • abatement required 2
  • MAC1 2.5(A1)2.5(___) 5.00
  • TAC1 1.25(A1)21.25(___) 2 5.00
  • (cost of 3 permits purchased87520.00)
  • Polluter 2 Current pollution level 10 units
  • of permit held
    2
  • abatement required 8
  • MAC2 0.625(A2)0.625(___) 5.00
  • TAC2 0.3125(A2)20.3125(___) 2 20.00
  • (revenue from 3 permits sold 87520.00)

32
Assessing the Model
Advantages
  • Trading establishes the price of a right to
    pollute without government trying to search for
    a price
  • Trading system is flexible
  • Note that an emissions standard can be adjusted
    by changing the number of permits issued
  • Cost-effective solution is obtained

33
Disadvantages
  • No tax revenues are generated
  • When there are too many buyers and sellers,
    transaction cost (the cost of conducting a
    negotiation) is big
  • The system creates pollution hot spots
    (localized areas face high concentrations of
    pollutants where most of the permit buying takes
    place)

34
Pollution Trading Systems in Practice
  • Most of the evolution of trading is occurring in
    U.S.
  • An important example is the allowance-based
    trading program to control sulfur dioxide
    emissions under the Clean Air Act Amendments of
    1990
  • More innovation has occurred at state and local
    levels
  • Ozone Transport Commission in the Northeast
  • California Regional Clean Air Incentives Market
    (RECLAIM)
  • Key international example
  • Trading of greenhouse gas allowances are part of
    the Kyoto Protocol, an international accord aimed
    at global warming
  • Includes the European Union Greenhouse Gas
    Emission Trading System (EU ETS), launched in 2005

35
Positive Externalities from Education
FYI
  • A more educated population benefits society
  • lower crime rates educated people have more
    opportunities, so less likely to rob and steal
  • better government educated people make
    better-informed voters
  • People do not consider these external benefits
    when deciding how much education to purchase
  • Result market eqm quantity of educationtoo low
  • How govt may improve the market outcome
  • subsidize cost of education

36
Other Examples of Positive Externalities
FYI
  • Being vaccinated against contagious diseases
    protects not only you, but people who visit the
    salad bar or produce section after you.

Thank you for not contaminating the fruit supply!
37
Positive Externalities
FYI
  • In the presence of a positive externality, the
    social value of a good includes
  • private value the direct value to buyers
  • external benefit the value of the positive
    impact on bystanders

38
A C T I V E L E A R N I N G 1 Analysis of a
positive externality
FYI
The market for flu shots
  • External benefit 10/shot
  • Draw the social value curve.
  • Find the socially optimal Q.
  • What policy would internalize this externality?

S
D
39
A C T I V E L E A R N I N G 1 Answers
FYI
  • Socially optimal Q ___ shots
  • To internalize the externality, use _______
    10/shot.

The market for flu shots
25
subsidy
S
Social value private value external benefit
D
39
40
Effects of Externalities Summary
FYI
  • If negative externality
  • market produces a larger quantity than is
    socially desirable
  • If positive externality
  • market produces a smaller quantity than is
    socially desirable
  • To remedy the problem, internalize the
    externality
  • tax goods with negative externalities
  • subsidize goods with positive externalities

41
FYI
Consumption externalities Consumption externalities Production externalities Production externalities
Positive Negative Positive Negative
The benefits to the rest of society of people being vaccinated before traveling abroad Noise pollution from using car stereos The benefits to the environment that arise from the planting of woodland by a forestry company Wastes being dumped into a river by a company
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