ch. 6.-pollution control instruments-pdf
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Perman et al.: Ch. 6
Pollution control: instruments
Outline of lecture
[Previous: Ch. 5. What is the socially optimal pollution level?]
Ch. 6. Pollution control instruments
Focus on cost-effectiveness of control instruments
Cost-Effective Pollution Abatement
• Cost-effective pollution abatement involves using abatement
instruments that can achieve
– target levels of pollution abatement
– at the lowest social cost.
• Consider two firms, A and B
– with marginal abatement costs of 60 and 100 respectively
If B were to reduce abatement by 1 unit and
A were to increase abatement by 1 unit
– Then total abatement would be unchanged
but the total cost of abatement would be reduced by 40 units.
Efficiency condition
Equal marginal abatement costs
• Costs are minimised when
– marginal abatement costs are equal for the two firms A and B
• This means that A will undertake more abatement than B
– to achieve a given aggregate level of pollution abatement.
• The total cost of pollution abatement for each firm is
– the area under its marginal cost curve (Fig. 6.1).
• The total cost of pollution abatement for society is
– the sum of the areas under each firm’s marginal cost curve.
5
10 15 35 40 30 25 20
Pollution abatement
Z
MCA = 3ZA
MC
MCB = 5ZB
75
100
200
Figure 6.1 Marginal abatement cost functions for the two firms.
Politically specified total abatement (A+B) target=40
For least-cost solution: necessary to find levels of ZA and ZB which add up to Z= 40
and which satisfy least-cost condition: MCA=MCB
A undertakes more abatement than B
because MCA<MCB
Two firms, A and B
6.3 Instruments for achieving pollution abatement targets
Instrument category
Institutional approaches
– to facilitate internalisation of externalities
Command and control instruments
Economic incentive (market-based) instruments
Table 6.2 Classification of pollution control instruments
6.3.1 Voluntary approaches
6.3.1.1 Bargaining
……
6.3.1.2 Liability
……
6.3.1.3 Social responsibility
Command and Control Instruments (6.3.2, p 188)
• Most regulators use direct controls to reduce pollution.
• These instruments can be classified according to what they target.
– Figure a illustrates the relationships that link production to pollution.
– Figure b names the instruments used to control pollution according to the
stage of production that they target.
• It is generally best to direct controls
– at the points closest to ambient pollutions levels, which is the target of the
regulation.
Location of
emissions
Ambient pollution
levels
Emissions output
Production technique
Inputs used
Quantity of goods produced
Fig 6.4a The pollution process
For non-UMPs
Start here
Zoning
Ambient pollution
requirements
Emissions
licenses
Technology controls
Input restrictions
Output quotas
Fig. 6.4b Command and control instruments
For non-UMPs
Best practicable means (BPM)
Best available technology (BAT)
Start here
Command and Control Instruments
Inefficient
• Least-cost solution requires that
– marginal abatement costs are equal for all polluters
• Normally, a regulator cannot acquire information about MC of individual
polluters
– Information costs prohibitive
– Information asymmetries
• Therefore, mandatory obligations/restrictions on behaviour of firms and
consumers
– Are not generally least-cost solutions to a pollution control problem.
Economic Incentive Instruments
• Incentive-based instruments create economic incentives
– for polluters to voluntarily change behaviour.
• Incentive-based instruments may be
– Taxes/levies
– Subsidies
– Transferable/tradeable pollution permits.
• Using incentive-based instruments create
– Opportunity costs* of pollution
Which profit maximising firms will take into account.
------------ * The opportunity cost is the value of the best foregone alternative.
Captures the idea that the cost of something is not just its monetary cost but also the value of what you didn’t get.
Input tax on nitrogen fertilizer
• Uncontrolled farmers will use nitrogen fertilizer
– until the marginal benefit of fertilizer application per hectare is zero.
• An input tax can be designed to achieve an socially efficient level of
fertilizer application
– the marginal social costs of pollution abatement are
– equal to the marginal social benefits of pollution abatement (Figures 6.5- 6.6).
Figure 6.5 An economically efficient emissions tax
0 Z* = *MM̂ Z
M̂
Emissions abatement, Z
*
Marginal benefit (for firm) before tax
0
*
Marginal benefit
after tax
M* Emissions, M
Marginal social damage
Marginal cost of abatement
Marginal benefit of abatement
Figure 6.6 The economically efficient level of emissions abatement (Uniformly mixed pollutant)
Efficient
emissions tax
Unregulated profit max. emission level
Socially efficient abatement level
and optimal for firm at tax rate μ*
Pollution tax on emissions
• A tax on emissions at a constant rate per unit of emissions
– Shifts the marginal benefit curve down
– Polluters will again emit pollution until the marginal benefit of emitting pollution is
zero
at a lower pollution level.
• Each firm is free to choose what methods to use to reduce emissions
– and (cost minimizing firms) will use the cheapest methods to do so.
Emissions tax/subsidy
Marginal damage unknown
• Suppose EPA does not have sufficient information
– to deduce the economically efficient level of emissions
– or it wishes to set an overall emissions target on some other basis.
• Figure 6.7 shows that
– to attain ANY specific emissions target using a tax or subsidy instrument,
– knowledge of the aggregate marginal benefit of emissions (= marginal abatement
costs) function would be sufficient
– This due to the fact that polluting firms behaviour is determined by marginal benefits.
M̂
Pre-tax or pre-subsidy marginal benefit
0
Emissions, M
Figure 6.7 Emissions tax and abatement subsidy schemes when marginal damage is unknown, or
when a target is being set on grounds other than economic efficiency
Post-tax or post-subsidy marginal benefit
M~. .
μ~ .
Abatement Subsidies versus Pollution Taxes
Abatement Subsidies
versus
Pollution Taxes
• If an industry is given a subsidy at a fixed rate (μ*) per unit of
pollution abated
– then the same level of emissions reductions would be achieved
– As in the situation where an equivalent tax was imposed.
• Subsidy might enlarge the industry
– Partially or wholly offsetting short run emissions reductions.
• The distributional effects of the tax and subsidy are different
– With subsidy, the industry gains income
– With tax, the industry loses income (Figure 6.8)
M̂
Marginal benefit
(before tax)
0
*
M* Emissions (M)
Marginal social damage
Figure 6.8 Emissions tax and abatement subsidy schemes: a comparison
S3 S4
S6 S2
S1 S5
Subsidy gives firm payment = μ* times (Mˆ – M*) = S1 and S2
minus foregone profits from reducing output = S2
Net gain (payment minus foregone profits from reducing output) = S1
Tax costs firms μ* times M*= S3, S4, S5, S6
+ foregone profits from reducing output = S2
Efficient abatement level
at tax rate or subsidy rate = μ*
Emissions before tax/subsidy
Tradable Emissions Permits
Emissions Permits
Allocated through auction
• We consider tradable permits on quantity of emissions
– Regulator determines total quantity of missions allowed
– Permits are allocated between polluters through a market.
• Emissions permits may be initially allocated through an auction.
– (Figure 6.9)
Figure 6.9 The determination of the market price of emissions permits.
Marginal abatement cost (aggregate)
= demand curve for permits
*
M̂M* M 0
Equilibrium price for permits
Total reduction in emissions = Mˆ – M* Supply of emission permits determined by regulator
Emissions Permits
Distributed at no charge
• If tradable permits are initially allocated arbitrarily to emitting firms,
– initial allocation will not be profit maximising for the firms
• Firms with low abatement costs will reduce their emissions and sell the
excess emissions permits
– at a price higher than their marginal abatement costs
• Firms with high abatement costs will buy permits
o so long as the price of a permit is below their marginal cost of abating
emissions.
• Marginal cost of abatement will be equal for all firms (Figure 6.10)
Demand for permits
*
EP* Emission permits
(EP)
0
Figure 6.10 The determination of the market price of emissions permits:
free initial allocation case.
Supply of permits
by firms
Price of a permit will be equal to the
marginal cost of pollution abatement
Relative advantages of different control systems
Cost-efficiency
• A command and control regulation instrument
– To be cost-efficient
the regulator must know each polluter’s marginal cost of
abatement function
very unlikely that this requirement will be met.
• For a flow pollutant and a uniformly-mixing stock pollutant
– an emissions tax, abatement subsidy or marketable permit system
– can achieve any emissions target at least cost
the regulator needs not know the individual polluter’s marginal
cost of abatement function.
The market mechanism will reveal that information.
Second-best world
• Policy instrument choice takes place in a ‘second-best’ world,
where results are much less clear
– absence of markets (including those for externalities and public
goods)
– asymmetric information, moral hazard and other instances of
market failure
point to possible benefits of command and control-based public
intervention
in particular circumstances.
Non-UMP stock pollutant
• For a non-UMP stock pollutant
– Cost-effective tax and subsidy instruments
require knowledge of individual firms’ marginal cost of
abatement functions.
– only transferable permit schemes do not require that knowledge.
Costs of
monitoring, administering and enforcing compliance
• These costs can be substantial.
• The prevalence of minimum technology requirements may be due
to the fact
– that these costs can be low
– relative to those of instruments that try to regulate emissions
output levels.
6.6.3 Long-Run Effects of Regulation
• The long-run effects of pollution control depend on
– net income effects and
– technological innovation effects.
• Market based pollution abatement regulations create a dynamic
incentive structure
– which continually reward the development of improved pollution
abatement technology.
• Taxes remove income from the targeted industry,
– which will cause it to shrink in the long-run.
• Subsidies will have the opposite effect.
MC1
MC2
£
0 Z Z1*
Figure 6.13 Dynamic incentives under emissions tax controls.
Z2*
New technology reduces marginal cost
of abatement from MC1 to MC2
At lower MC:
firm’s abatement level will increase from Z1* to Z2*
Emission
tax/subsidy
Level of abatement
Firm will save:
Ω due to lower MC of abatement
+ Λ due to reduced tax payment
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