Chapter 17

Externalities

and the Environment

© 2009 South-Western/ Cengage Learning

Externalities

• An externality is a cost or benefit associated with a transaction not borne by the decision maker– Full benefits and/or full costs not included

in market price

– Pollution • External cost

– Education• External benefit

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Optimal Level with negative externality

• External costs with fixed technology– Marginal social cost

• Marginal private cost• Marginal external cost

– Set MSC = MSB• Optimal Q* & P*

– Set MC = MB• Too much produced at too low a price

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Positive Externalities

• Education– Personal benefits– Benefits to society

• Set MSC = MSB– Optimal Q* and P*

• MC = MB– Too little consumed at too low a price

• Public policy– To increase quantity beyond private optimum

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Optimal Level with negative externality

• To achieve socially efficient production– Demand (marginal benefit) intersects

marginal social cost curve

– Government regulation• Limit production• Tax = marginal external cost

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Optimal Level with positive externality

• To achieve socially efficient production– Demand (marginal benefit) intersects

marginal social cost curve

– Government regulation• Subsidy = marginal external benefit

–Subsidize consumers–Subsidize producers

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Optimal Level of Pollution

• External costs with variable technology– Variable technology

• Reduce emissions: alter the production process

• Cleaner technology

– Production of cleaner air• Diminishing returns

– As air becomes cleaner it is harder to make cleaner still

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Optimal Level of Pollution

• Reducing greenhouse gases– Marginal social cost curve

• Marginal cost of enduring pollution• Upward-sloping

– Marginal social benefit curve• Marginal cost of reducing pollution• Downward-sloping

– Optimal level of air quality• Marginal social benefit = marginal social cost

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Optimal Level of Pollution

• Shift in marginal social cost curve– Technological breakthrough: Lower

marginal cost of cutting greenhouse gas• Downward shift of MSC curve• Lower optimal level of emissions

• Shift in marginal social benefit curve– Higher marginal benefit of reducing

emissions• Upward shift of MSB curve• Lower optimal level of emissions 9

Criticisms of Economic Analysis

• Measurement problems– Cost of enduring pollution

• Not all costs are easily quantified

– Cost of removing pollution• Technological

–More easily quantified

• Who has the right to clean environment?– World does not run by economic trade-

offs alone10

Optimal Level of Pollution

• The Coase theorem – Problems of externalities will be resolved

efficiently through private exchange, regardless of the assignment of property rights, so long as there are no transactions costs

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Optimal Level of Pollution

• Coase Theorem– Efficient solution

• Least cost solution • Assign property right to one party• One side bears the externality cost

– Transactions costs arise• Scientific and technical uncertainties • Legal uncertainties• Costs of negotiation

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How to Achieve Optimal Level of Pollution

• Command & Control– Engineering controls and pollution

ceilings• Not efficient

• Legal system– Tort law

• Difficulties arise

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How to Achieve Optimal Level of Pollution

• Pollution Charges– Efficiency can be achieved

– How large is tax?

– Polluters have “right” to pollute

• Market for pollution rights – Government sells pollution rights

• Limits maximum level of pollution per day

– Firms buy and sell pollution permits

– Value of pollution permits fluctuates14

Pollution Rights and Public Choice

• Pollution regulation– Special interest of polluters

• Before 1990– Command-and-control environmental

regulations• Particular technologies to reduce emissions

• Market for pollution rights– Economic efficiency approach

• Reduce emissions: Cost-effective15

Environmental Protection

• Environmental Protection Agency EPA• Clean air act of 1970• Clean water act of 1972• Resource conservation and recovery act

of 1976• Superfund law of 1980

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Air Pollution

• Atmosphere– Economic resource

– People value clean air; willing to pay more

• Smog– 40% from automobile emissions

– 40% from consumer products

– 15% from manufacturing

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Air Pollution

• Clean air act of 1970– 90% reduction in auto emissions

– By 1990, average emissions fell• Lead: 97%• Monoxide: 41%• Sulfur dioxide: 25%

• U.S. air quality: good• U.S. – major source of fossil-fuel carbon

dioxide emissions18

Water Pollution

• Sources– Sewage

– Chemicals

• Sewage– Dumped into waterways; no cleaning

• Negative externality

– Federal money: treatment plants

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Water Pollution

• Chemicals– 10% from point pollution

• Factories, industrial sites

– Two thirds – from nonpoint pollution• Agricultural pesticides and fertilizers

– In most states: pesticides have fouled some groundwater

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Hazardous Waste and the Superfund

• Before 1980– Firms

• Pay others to haul and dispose• Not responsible for cleaning

• Superfund law of 1980– Companies

• Pay others to haul and dispose• Pay for clean up

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Solid Waste:”Paper or Plastic?”

• U.S. households– 4 pounds of garbage per resident per day

• Mostly packaging

– 200 million tons per year

• 70% of garbage - landfills• Recycled: 15% of garbage

– 75% paper products

• 15% - incinerated – Trash-to-energy plants 22

Solid Waste:”Paper or Plastic?”

• 2 out of 3 aluminum cans: recycled• Returnable deposit laws

– Increase recycling

• Recycling: imposes environmental costs– Curbside recycling

• Trucks

– Newsprint• De-inked

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