CHAPTER 14: ECONOMICS OF POLLUTION CONTROL

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1 CHAPTER 14: ECONOMICS OF POLLUTION CONTROL I. Introduction A. Up until this point, we have focused on the flow of resources into the "economic system" Economic System outputs Firms Households inputs extraction residuals Natural Life Support System Air, Water, Wildlife, Energy Raw Materials, Amenities ASSETS B. We now want to talk about the flow of wastes back into the system, specifically addressing two questions 1. What is the appropriate level of waste flows? 2. How to allocate the flows? Will the market work? II. A Pollution Taxonomy A. B. The damage caused by waste disposal depends crucially upon the environment's ability to absorb the waste. DEFINITION: The absorptive capacity refers to the environment's ability to absorb waste products. 1. Note: It is not that the system destroys the waste (this would contradict the first law of thermodynamic). Rather, the system transforms it into a substance not considered to be harmful to the ecological system, or dilutes it so that the resulting concentration is not harmful. 14-1

2 2. Examples: a. Carbon dioxide is absorbed by plant life b. Organic pollution in waterways can be transformed into less-harmful inorganic matter by bacteria in the waterways. 3. If emissions exceed the absorptive capacity of the system, they will accumulate in the environment and cause damage. Absorptive Capacity of the Environment Emissions Load Pollution Accumulation Pollution Damage C. Classification of Pollutants 1. By absorptive capacity a. DEFINITION: A stock pollutant is a pollutant for which the environment has little or no absorptive capacity. Examples: i. Nonbiodegradable bottles i Heavy metals (e.g., lead) Some synthetic chemicals (dioxins and PCB's) b. DEFINITION: A fund pollutant is a pollutant for which the environment has some absorptive capacity. Examples: i. Carbon dioxide 14-2

3 waste paper products 2. By Horizontal zone of influence a. DEFINITION: The damage caused by a local pollutant is experienced near the source of the emissions. i. Nonbiodegradable plastics b. DEFINITION: The damage caused by a regional pollutant is experienced at greater distances from the source. i. sulfur dioxides from coal emissions is believed to be a culprit in the acid rain problem. carbon dioxide Note: It is possible for a pollutant to be both. Example: carbon dioxide 3. By Vertical zone of influence a. DEFINITION: A surface pollutant is one whose damage is determined mainly by the concentration of the pollutant near the earth's surface. Example: i. water pollutants plastics b. DEFINITION: A global pollutant refers to a pollutant whose damage is determined by its concentration in the upper atmosphere. Examples: i. carbon dioxide is often cited as a contributor to the greenhouse effect. Chloroflourocarbon emissions are linked to ozone depletion. 4. The above taxonomy is useful because, as we shall see, different pollutants require different policies. Failure to recognize these distinctions can lead to flawed, counterproductive policies. III. The Efficient Allocation of Pollution 14-3

4 A. B. C. As in all previous chapters, the efficient allocation is one that maximizes the present value of the net benefits. Different approaches need to be considered in dealing with fund versus stock pollutants. Stock Pollutants 1. Question: Can stock pollutants be treated in a static framework? No. By their very nature, stock pollutants create interdependencies between decisions made today and the welfare of future generations. 2. Example: a. Consider a good (X) whose production costs are zero and for which consumers perceive a marginal net benefit of MB = A. b. Question: How much will the firm produce? An infinite amount. c. Now suppose the production process also generates a stock pollutant, with a marginal costs to society of MC = ba for each period exposed to the pollutant. Suppose further that b =.1. d. Should another unit of the good be produced today? PV[MNB] = PV[MB] - PV[MC] = A - {ba + ba/(1+r) + ba/(1+r) } = A - ba{1 + 1/(1+r) + 1/(1+r) } = A - ba[1 + 1/r] 14-4

5 % 7.% 9.% 11.% 13.% 15.% 17.% Stock pollutants have many of the same problems as nonrenewable resources with rising extraction costs. a. What is done today has a permanent effect on all future generations. i. Emitting pollutant extracting resources MC of emission on society increases as stock of pollutant increases MC of extraction increases as stock of resource decreases. b. In fact the efficient solution is the same. i. The quantity of X produced over time should decline as the marginal cost of damage increases. This will lead to a reduction in the amount of pollution. The price of X should increase over time to reflect the increased social cost of pollution. 14-5

6 i iv. Resources committed to pollution control should increase over time. Eventually, a steady state will be reached where additions to the stock of pollutants would cease, with emissions controlled instead. c. Technological change can modify the efficient allocation by: i. Developing ways of recycling the pollutant Developing ways of making the pollutant less harmful. D. Fund Pollutants. 1. Fund pollutants are to stock pollutants what renewable resources are to nonrenewable resources. a. If emissions of fund pollutants exceed the absorptive capacity of the system, then the pollutant will accumulate. This is similar to the regenerative capacity in renewable resources. b. If the emissions are less than the absorptive capacity, no problem exists. However, as in renewable resources, one has to be concerned with what processes are allowed to contribute to using up the renewable resource: "absorptive capacity." 2. Suppose a product is going to be produced (i.e. fix the output level), generating Q units of pollutants without abatement. What is the efficient amount of pollution emissions versus pollution control. 14-6

7 MC Marginal Cost of Control Marginal Damage Cost Q Quantity of Pollution Emitted a. There are two marginal cost curves, both of which are increasing. i. The marginal cost of pollution damage is increasing. small amounts of pollution have only minor effects. The marginal cost of pollution control is increasing. It is harder to control all emissions than the first portion of emissions. b. Question: Is zero the efficient level of fund pollution? i. Not necessarily. In this diagram, the optimal level is Q *. If damage costs are high enough, however, it can be efficient. 14-7

8 MC Marginal Cost of Control Marginal Damage Cost TC d TC c Q * Quantity of Pollution Emitted c. We would generally expect the optimal level of pollution to vary by region and by types of pollution. IV. The Market Allocation of Pollution A. Question: Does the market naturally lead to the optimal allocation of pollution emissions? 1. No, due to the common property aspects of air and water. 2. Pollution is an externality. B. The argument for government intervention in this case is particularly strong. V. Cost Effective Policies. A. Efficient policies of achieving Q* 1. Impose a legal limit 2. Taxing pollutants 3. The amount of information needed in order to determine the efficient level of pollution is enormous and existing estimates are uncertain. B. Cost effective policies 14-8

9 1. Instead that we focus on how to achieve a predetermined level of pollution reduction in the most cost-effective manner. 2. There are two types of pollutants to consider in this respect. a. DEFINITION: A uniformly mixed fund pollutant is one whose damage depends upon the total amount of the pollutant entering the system. b. DEFINITION: A non-uniformly mixed fund pollutant is one whose damage is relatively sensitive to where emissions are injected into the system. C. Uniformly Mixed Fund Pollutants 1. In this case the focus can be on minimizing the total pollution level and ignoring distributional impacts. 2. What is the cost effective allocation of control responsibility for uniformly mixed fund pollutants? a. The cost of achieving a given reduction in emissions will be minimized if and only if the marginal costs of control are equalized for all emitters. MC 1 MC 2 MC MC q 1 q b. In the graph we have two sources of pollution, with a goal of reducing emissions by 15 units. For a more formal example, suppose we start with two firms, with firm 1 initially emitting units of pollution and firm 2 initially emitting 5 units of pollution. Suppose we want to control that pollution down to a total of 55 units of pollution? E1 = E2 =

10 Goal: reduce total emissions to 55 Question: How should the pollution control be allocated between the two firms? We need to know the relative costs of pollution control. Suppose MC1 = q1 MC2 = 2q2. Where qi denotes the quantity of pollution controlled by firm i. Our goal is: (E1 - q1) + (E2 - q2) = 55 or q1 + q2 = 15 or q2 = 15 - q1 We have a second piece of information (cost effectiveness): MC1 = MC2 or q1 = 2q2 = 2(15 - q1) = 3-2q1 3q1 = 3 q1 = 1 q2 = 5. Graphically, we have: 14-1

11 MC 1 MC q 1 q How to Achieve the Optimal Allocation? Cost-Effective Pollution Control Policies a. General Points i. The cost of pollution control for the same pollutant can be expected to vary by industry and within industries, depending upon The size of the operation The age of the plant etc. The best source of information on the costs of pollution control will likely lie with the plant managers. It is not realistic to expect industries to convey accurate information on pollution control costs. They will tend to overestimate the costs. b. Alternative policy I: emission standard i. DEFINITION: An emissions standard is a legal limit on the amount of a pollutant that an individual source is allowed to emit. i This is referred to in the literature as the "command and control approach." Using the figure below, it is clear that a uniform standard is not cost-effective in this case

12 MC 1 MC q 1 q 2 TC 1 TC iv. It is unlikely that the government would be able to determine the cost-effective allocation. It does not have the necessary information to do so. c. Alternative Policy II: emission charge i. DEFINITION: An emissions charge is a fee, collected by the government, levied on each unit of pollution emitted. MC 1 3 MC 1 1 T q i How would the firm choose to control its pollution level faced with an emissions charge of T? The firm should move to where the MC of control equals the emissions fee. Suppose we now look at both firms

13 MC 1 MC q 1 q iv. We can get to the efficient allocation of pollution control by setting the right level of T (T=1). It is better tan emission standards in a number of ways: The firms now control in the least cost manner relative to each other, without the government knowing the costs of pollution control for each firm. An iterative method can be used to achieve the efficient allocation by comparing the pollution abatement goal with actual impacts. Firms have an incentive to adopt new technologies in pollution control, while standards create incentives for firms to hide new control technologies. v. The problem with emissions charges is that finding the efficient level can be costly and time consuming. d. Alternative policy III: transferable emission permits i. DEFINITION: Under a transferable emissions permit system, all sources are required to have emissions permits matching their actual emissions, with each permit (a) (b) specifying how much the firm is allowed to emit and being freely transferable. Under this system the control authority issues exactly the number of permits needed to produce the desired emissions level

14 i iv. Severe monetary sanctions are imposed upon sources polluting in excess of the amount allowed by its permits. Example: Consider our earlier example where 15 units of pollution are to be controlled. MC 1 MC P 2 1 P 1 1 q q What will the equilibrium price be? v. Notice that trading yields the most cost-effective allocation of clean-up among the two firms. vi. Initial allocation of permits does not affect efficiency: it only has distributional consequences. D. Non-uniformly mixed fund pollutants 1. Non-uniformity complicates the problem considerably. 2. Total emissions is no longer the sole source of concern. We must also consider the emissions site and its impact on concentration levels at other sites. 3. It is easy to see why in many cases location does matter, especially when the absorptive capacity of alternative locations differ. 4. This whole problem leads to considering ambient standards. 5. DEFINITION: Ambient standards are legal ceilings placed on the concentration level of specified pollutants in the air, soil and water. 6. The target concentration levels are measured at what are called receptor sites

15 7. The single receptor case. a. Location of the emissions source matters relative to the receptor site. b. River example: 1 c. DEFINITION: A transfer coefficient, a i, measures the constant amount that the concentration at the receptor will rise if source i emits one more unit of pollution. d. The cost effective allocation will be achieved when the marginal cost of concentration reduction (not emissions reduction) are equalized. e. Example i. Suppose we have two firms, both of which incur a marginal cost of emissions reduction of MC1 = MC2 = q for reducing their emissions by q units. Suppose that firm 1 has a transfer coefficient of 1 and firm 2 has a transfer coefficient of.5. That is, firm 1's reduced emissions reduce concentration at the receptor site on a 1:1 basis. On the other hand, it takes firm 2 twice as much emissions reductions as firm 1 to have the same effect on the receptor site concentration. Source 1 (a1 = 1) MC of Emissions Concentration Marginal Cost of Concentration Reduction Emissions Reductions Reduction Reductions

16 Source 1 (a1 =.5) MC of Emissions Concentration Marginal Cost of Concentration Reduction Emissions Reductions Reduction Reductions In an effort to reduce concentration at the receptor site by 5 units, we would want firm 1 to reduce emissions by 4 units and firm 1 to reduce emissions by 2 units. i Mathematically, our problem is: a1q1 + a2q2 = 5 q1 +.5q2 = 5 q1 = 5 -.5q2 We also want cost effectiveness, requiring equalization of MC of concentration reduction (not emission reduction) 14-16

17 MC MC where MC MC a q1 q2 = 1 5. q 1 c1 2c 1 = = 2q 1 2 c MC2 = a 2, MCe = a Combining this with our goal, we have: 5. 5q = 2q 5 = 2. 5q q 2 = q = 2q = iv. Graphically, we have: MC c1 MC c a 2 q a 1 q f. Policies 14-17

18 i. Ambient standard Ambient Charges A source pays ti per unit emitted, where ti = aif, where F is a fee used to adjust the level of pollution controlled. In our example, we would want to set F = $4. An iterative process can be used, in much the same way it was used under emissions charges. Notice, however, that the government now needs considerably more information, namely the transfer coefficient. i iv. An ambient permit system can be designed as well. The ambient permit entitles the owner to cause concentration to rise at the receptor site by a specified amount, rather than allowing emissions to rise. 8. The Many Receptor Case. The higher the transfer coefficient of the firm, ceteris paribus, the more permits the firm is going to want. The higher the transfer coefficient, the smaller the amount of emissions legitimately allowed to the firm by the permit. a. This represents a simple generalization of the single receptor case. b. Ambient charges can be set for each receptor at: Tij = aijf c. In essence, each firm pays: T = N a F i ij j j= 1 d. Ambient permits can be set for each receptor site. VI. Question: What are the distinctions among standards, permits, and charge systems? A. B. Standards are not only information intensive or likely no cost effective, but they also are less likely to encourage innovation in pollution control Permit systems adjust automatically, while the charge system must iterate to a solution

19 C. Problems for charges versus permits: 1. Charges do not react to changes in the number of sources. a. Adding sources will not change the permit result, just the value of the permits being traded. b. Adding sources will increase pollution in the absence of changes in the charge system. 2. Charges will not react to inflation unless they are modified. Permits will automatically adjust. D. Permits will not enable technological change in pollution control to alter the overall level of pollution, but a charge system will. MC 1 3 MC 1 MC 1 1 T q E. The two systems differ in the cost of being wrong. 1. Permit systems lead to certainty in the total level of pollution emissions. This is important when the marginal damage function is steeply sloped. A. Charges lead to certainty in the marginal control costs. This is important when the marginal control cost function is steeply sloped

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