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Economics of Environmental Policy. Environmental Policies. Decentralized Policies Liability Laws and Property Rights Moral Suasion Command and Control Emission Standards Technology Standards Incentive-Based Policies Emission charges Subsidies Tradable discharge permits.

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environmental policies
Environmental Policies
  • Decentralized Policies
    • Liability Laws and Property Rights
    • Moral Suasion
  • Command and Control
    • Emission Standards
    • Technology Standards
  • Incentive-Based Policies
    • Emission charges
    • Subsidies
    • Tradable discharge permits
criteria for evaluating policies
Criteria for Evaluating Policies
  • Efficiency
  • Cost Effectiveness
  • Fairness
  • Incentives for Technological Improvements
  • Enforceability
  • Morality
efficiency
Efficiency
  • Maximum net benefits
    • Requires balancing MAC and MD
  • Decentralized……………….Centralized
    • Hayek’s critique

Rational central planning is impossible

  • Cost Effectiveness:
    • When damages (benefits) can’t easily be measured
slide5

Garden of Eden

Adam and Eve in the Garden of Eden, by Titian (c. 1550)

which allocation would you choose
Which allocation would you choose?
  • Choice One
  • Choice Two
  • Choice Three
  • Choice Four
  • Choice Five

Tradeoff: Efficiency vs. Fairness ?

fairness
Fairness
  • Distribution of benefits/costs across regions, incomes, race, etc
if you could impose any of the four programs which would you choose
If you could impose any of the four Programs, which would you choose?
  • Program A
  • Program B
  • Program C
  • Program D
if your choices were limited to program c or program a which would you choose
If your choices were limited to Program C or Program A, which would you choose?
  • Program A
  • Program C
incentives for technological improvements
Incentives for Technological Improvements
  • Shift the MAC curve down

MAC1

MD1

MAC2

E2

E1

E0

Emissions

incentives for technological improvements1
Incentives for Technological Improvements
  • Incentives for private sector to innovate
    • Profit motive
    • New ideas are a public good

 undersupply problem

  • Pollution Control industry: “envirotech”
    • Driven by regulations and profit motive
enforceability
Enforceability
  • Enforcement is costly
    • Reliance on self-reporting
    • Monitoring
    • Sanctioning
      • Courts
      • Fines

 Paradox of the Reluctant Enforcer

moral considerations
Moral Considerations
  • Right vs. wrong
  • Taxes vs. Subsidies vs. Permits

The Animal Liberation Front (ALF) carries out direct action against animal abuse in the form of rescuing animals and causing financial loss to animal exploiters, usually through the damage and destruction of property.

decentralized policies
Decentralized Policies
  • Liability Laws
  • Property Laws
  • Voluntary action
liability law
Liability Law
  • Polluters must compensate those harmed
    • Provides incentive to make careful decisions
    • “internalize the externality”
slide16

Which of the following situations would provide a system of liability rules the best chance for generating an efficient level of emissions?

  • many people are involved, causal links are clear, and damages are difficult to measure.
  • few people are involved, causal links are clear, and damages are difficult to measure.
  • many people are involved, causal links are muddy, and damages are easy to measure.
  • few people are involved, causal links are clear, and damages are easy to measure.
liability law1
Liability Law…

$

Suppose firm is liable for pollution damages

  • At E0: TD = b + c + d
    • Reducing emissions reduces Damage Liability (saves “c+d”)
    • Reducing emissions increases Abatement Costs (costs “c”)
    • Threat of lawsuit could encourage optimal emissions

MAC1

MD1

d

b

c

Emissions

E0

E*

common law
Common Law
  • Legal Doctrines
    • Strict Liability
      • Liable for damages regardless the circumstances
    • Negligence
      • Liable only if appropriate precautions are not taken
  • Burden of Proof?
    • Burden is on victims
    • Statute of limitations
  • Standard of Proof?
    • Direct causal link must be established
    • Difficult given the probabilistic nature of many exposures
examples
Examples
  • Smoking “causes” cancer?
  • Exxon Valdez “caused” shoreline damages?
  • Particular power plant “caused” SO2 damages?
  • Best Case Scenario for Common Law

Few people involved, causal link is clear, damages easily measured

under a system of negligent liability a firm disposing hazardous materials into a river would
Under a system of negligent liability, a firm disposing hazardous materials into a river would:
  • be liable for any damages regardless of the circumstances.
  • be liable for any damages only if the firm did not take reasonable steps to avoid damage.
  • not be liable for any damages.
  • none of the above.
statutory law
Statutory Law
  • Legislative enacted laws
    • Tax-financed victim’s fund (Netherlands)
    • Law for the Compensation of Pollution-Related Health Injury (Japan)
    • CERCLA (US)
  • Example: #4 from Problem Set
slide22

In March a small dump truck overturned in Marietta, Ohio, littering the street with cow parts. A smaller shipment fell off of a truck on the same street the following week, running the total of cow-parts spills to four within a year. Said City Councilwoman Katie McGlynn, "I would just like to know why this continues to happen. Maybe we need a stronger ordinance to make this a more serious crime."

[Marietta Times, July 1993]

4. Accidents with trucks carrying cow renderings are fairly common in Marietta. Suppose regulators enact a rule requiring that the perpetrators of such an accident be liable for a sum equal to the average damages of all such accidents in the industry. Would this lead trucking companies to take the socially efficient amount of precaution against such accidents? Explain.

property rights

Ronald Coase

1991 Nobel Prize in Economics

Property Rights
  • Coase Theorem
    • If property rights are well-defined and transactions costs low, then private bargaining will lead to an efficient allocation of resources
      • Corollary: efficient allocation does not depend on initial allocation of property rights
    • Conditions
      • “well-defined” property rights
      • low transactions costs
      • complete markets
slide24

A factory's production process creates sludge which pours into a river. This sludge makes it difficult to fish in the river, increasing the costs of the local fishermen by $6000. The factory can install a water filter system for $4500, and the fishermen can utilize a weighted fishing net system (to get under the sludge) for $3750. Both systems would remedy the sludge damage to the fishermen.

  • a) Suppose transactions costs are zero. If the factory is not liable and can continue to produce sludge, what outcome do you predict and why?
  • b) Suppose transactions costs are zero. If the factory is assigned liability for sludge damage, what outcome do you predict and why?
  • c) Now suppose transactions costs preclude the possibility of private bargaining between the factory and fishermen. If a pollution tax is levied on the factory with the proceeds given to the fishermen, then what outcome do you predict and why?
  • d) How do your answers to parts (a), (b), and (c) change if the cost of the water filter system was $3500?
  • e) Discuss the results of parts (a), (b), (c), and (d) in terms of the Coase Theorem.
voluntary action
Voluntary Action
  • Moral suasion
  • Informal community pressure
command and control policies
Command and Control Policies
  • Mandate behavior coupled with enforcement
  • Examples
    • Speed limits
    • Minimum age restrictions
    • Minimum wage
  • Why are standards popular?
    • Simple and direct
    • Moral appeal
ambient standards
Ambient Standards
  • Never exceed level of a pollutant in ambient environment
    • DO can not fall below 3ppm
  • Expressed in terms of average concentration over time
    • SO2: 80 μg/m3 annual; 365 μg/m3 daily
  • Can’t be enforced directly; must monitor emissions that lead to AQ levels
emission standards
Emission Standards
  • Never exceed levels applied directly to quantities of emissions
  • Expressed in terms of quantity per time
    • Tons per week
    • Grams per hour

Emissions  Environment  AQ

Meteorlogical

Hydrological

Human decisions

technology standards
Technology Standards
  • Mandated technologies, techniques, and practices
  • Examples
    • seat belts
    • catalytic converters
    • Scrubbers/baghouses
economics of standards
Economics of Standards
  • Setting the standard
    • Should EPA consider damages and abatement costs?
    • Zero-Risk?
    • Reasonably small level?
    • Efficient level?

 tradeoffs made by using avg. concentration levels over time

$

MAC

MD

Emissions

Et

E1

E*

E0

uniformity of standards
Uniformity of Standards
  • Geographic differences: MDu > MDr
  • Single standard can’t be efficient

 tradeoff: regulatory costs vs efficiency gains

$

MDu

MAC

MDr

Emissions

Eu

Er

E0

incentives for improvements
Incentives for Improvements
  • Technology Standards: no incentive
    • All or nothing!
  • Emission Standards: some incentive
    • Polluters seek to reduce abatement costs
    • Remember: pollution control R&D carried out by pollution-control industry rather than polluting industries themselves
slide34

MAC1

$

MD

MAC2

e

d

a

c

b

Emissions

E2

E1

E0

With MAC1: cost at E1 = a + b

If E1 is the standard, then the incentive

for R&D = a “cost savings”

With MAC2: cost at E1 = b

If standard is changed to E2 as new technology is adopted, then incentive

to innovate is (a – c)

Technology Forcing: If standard is set at E2 from the start then incentive to

Innovate is (a + d + e)

input standards or output standards
Input Standards or Output Standards?

E = [Q] x [Inputs/Q] x [E/Inputs]

Auto Emissions = [# Vehicles] x [Miles/Vehicle] x [Emissions/Mile]

Emission Standards

“end of tail pipe”

economics of enforcement
Economics of Enforcement
  • Monitoring & Sanctioning Costs

MPC = Marginal Penalty Curve = P x F x E

    • With MPC1, firm only cuts back to E1
    • To get to E*, must raise MPC1 to MPC*
      • Raise P
      • Raise F

P = probability of detection

F = monetary fine

E = emissions

$

MAC

P = 0.25

F = $100/E

E = 10,000

MPC = (.25)(100)(10,000)

= $250,000

MPC*

MPC1

Emissions

E*

E1

E0

how do standards hold up
How do Standards Hold Up?
  • Efficiency
  • Cost Effectiveness
  • Fairness
  • Incentives for Technological Improvements
  • Enforceability
  • Morality
incentive based strategies
Incentive-Based Strategies
  • Emission Taxes
  • Emission Subsidies
emission taxes
Emission Taxes
  • Pigouvian taxes
  • Government sets tax = $t per unit of emissions
  • Polluter has incentive to reduce emissions until MAC = t
  • Standard at E1 would only cost firm area "b"; much less than the tax

$

MAC

Tax bill

t

Abatement Cost

b

Emissions

E0

E1

optimal tax
Optimal Tax
  • Optimal t* occurs where MD = MAC

MD

Reduced damages = e + f

MAC

Remaining damages = b + d

Tax cost = a + b + c + d

f

t*

[Tax revenues are not included

in social cost calculation]

c

a

d

e

b

Two-part tax?

Allow E1 emissions free

E0

E1

E*

Apply t* to anything above E1

Tax payment = c + d

If MD is unknown, use iterative process:

If AQ doesn’t improve  raise t

If AQ improves too much  lower t

slide41

Suppose that society's marginal abatement cost function is given by MAC = 50 - 2E and society's marginal damage function is given by MD = 3E. What is the optimal level of pollution emissions?

  • 50
  • 30
  • 20
  • 10
  • 5
according to the situation above what would be the optimal per unit pollution tax
According to the situation above, what would be the optimal per unit pollution tax?
  • $50
  • $40
  • $30
  • $20
  • $10
efficiency1
Efficiency
  • Uniform Emissions
    • Equimarginal principle is satisfied
    • efficiency results possible even though agencies may know nothing about MAC at sources (unlike standards, where agencies must know MAC)
  • Non-Uniform Emissions
    • single tax not fully efficient: deals with differences in MAC, but not differences in MD
    • 1 unit reduction by Firm B is better than 1 unit reduction by Firm A

Firm A

Firm B

zoned taxes
Zoned Taxes?
  • Warning: reducing emissions through one medium may increase emissions elsewhere
incentive to innovate
Incentive to Innovate

MAC1

MAC2

t*

c

d

a

b

e

E0

E2

E1

With tax t*:

MAC1: Cost = (d + e) + (a + b + c)

MAC2: Cost = (b + e) + (a)

Recall: cost savings for standard

at E1 was only d.

Cost savings = c + d

enforcement and examples
Enforcement and Examples
  • Enforcement costs
    • Higher monitoring requirements compared to standards
    • Non-point sources are difficult to monitor/tax
    • Revenues give regulators incentive to monitor
  • Examples
    • CO2 taxes: Scandinavia
    • State emission fees for criteria pollutants
south coast aqmd
South Coast AQMD

Source: South Coast AQMD, Rule 301, Table III. Available at http://www.aqmd.gov/rules/reg/reg03/r301.pdf

enforcement and examples1
Enforcement and Examples
  • Enforcement costs
    • Higher monitoring requirements compared to standards
    • Non-point sources are difficult to monitor/tax
    • Revenues give regulators incentive to monitor
  • Examples
    • CO2 taxes: Scandinavia
    • State emission fees for criteria pollutants
    • tax on cars to control auto emissions

total emissions per year = (E/mile) x (# miles per year)

    • Gasoline taxes
slide49

Federal tax is 18.4 cents per gallon

Source: http://www.factsonfuel.org/gasoline/index.html

more examples
More examples…
  • Non-point sources
    • Agricultural runoff
      • pesticides
      • fertilizer
  • Distortions?
    • Trash stickers
      • pack more garbage into each bag
    • tax on house windows

Tax the input, rather than output

distributional concerns
Distributional Concerns
  • Regulatory costs may be passed on
    • to consumers through higher prices
    • to workers through reduced employment (and lower wages)

S2

S1

$

P2

P1

D1

Quantity

Q2

Q1

subsidies
Subsidies
  • Types
    • technology subsidies
    • abatement subsidies
  • while emissions per firm may go down, new firms may be attracted to the industry!
  • Examples:
    • deposit refund systems:
      • Cars
      • Batteries
      • Bottles/cans
    • Tax credits

5¢: CA, CT, DE, HI, IA, ME, MA, NY, OR, VT

10¢: MI

pollution worksheet
Pollution Worksheet
  • Marietta-Parkersburg area emissions:
    • Current emissions = 90,000 units
    • Optimal emissions = 60,000 units
  • Marginal Abatement Cost
    • Cars: $5
    • Utilities: $10
    • Factories: $20
  • Controlling pollution through:
    • Standards
    • Taxes
    • Tradable Permits
standards
Standards

Set a maximum emissions of 20,000 units per source:

20,000

0

0

20,000

10,000

$100,000

20,000

20,000

$400,000

60,000

30,000

$500,000

standards1
Standards

Require each source to cut emissions by 10,000 units:

10,000

10,000

$50,000

20,000

10,000

$100,000

30,000

10,000

$200,000

60,000

30,000

$350,000

standards2
Standards

Require each source to cut emissions by 1/3:

13,333

6,667

$ 33,335

20,000

10,000

$100,000

26,667

13,333

$266,660

60,000

30,000

$399,995

standards3
Standards

Cost-minimizing strategy of reducing emissions by 60,000 units.

0

20,000

$100,000

20,000

10,000

$100,000

40,000

0

0

60,000

30,000

$200,000

“$200,000 Solution”

taxes
Taxes

A tax of t = $6 per unit of pollution is imposed:

0

20,000

$100,000

0

30,000

0

0

$180,000

40,000

0

0

$240,000

70,000

20,000

$100,000

$420,000

taxes1
Taxes

A tax of t = $11 per unit of pollution is imposed:

0

20,000

$100,000

0

0

30,000

$300,000

0

40,000

0

0

$440,000

40,000

50,000

$400,000

$440,000

tradable permits
Tradable Permits

S

$

F

$20

Abatement Cost

U

$10

P = $10

Q = 60,000

Auction

Revenue

C

$5

D

= MAC

40

60

70

90

permits

“$200,000 Solution”

tradable discharge permits
Tradable Discharge Permits
  • TDPs rely on decentralized cooperation
    • Central authority sets aggregate # permits (CAP)
    • Each polluter is allocated certain number of emission permits
    • Each permit allows 1 ton of SO2
    • Polluter must then make a choice:
      • Reduce emissions to level covered by allocated permits
      • Reduce emissions below original permit level, then sell excess permits
      • Buy additional permits (to enable expanded production)
permit market
Permit Market
  • Buyers
    • New firms
    • Existing firms looking to expand
  • Sellers
    • Firms leaving area/industry
    • Those who’ve invested in efficient technology

S

$

P*

D

Q*

Permits

Permits flow from low MAC polluters to high MAC polluters so as to satisfy equimarginal principle

2008 Spot Auction

2008 7-yr Advance Auction

trading rules
Trading Rules
  • Should be simple and clear to minimize uncertainty
  • Initial Permit Allocation?
    • Equal allocation?
      • Ignores differences in firm size
    • According to existing emissions?
      • Ignores that some firms have already cut emissions
    • Give away or auction?
      • Coase Theorem
trading rules1
Trading Rules…
  • Who may participate?
    • Local, regional, national, international polluters?
    • Environmental groups?
    • Speculators?
  • How will trades take place?
    • Sealed bids for annual EPA auction
    • Brokers are used for secondary markets
    • Do regulators have veto power?
potential problems
Potential Problems
  • Market power
  • Thin markets
  • Permit life span
  • Hot spots (non-uniform emissions)
    • Tradeoff: competitive markets vs. enviro damage

Urban Area

“transfer coefficient”

B

C

A

D

Prevailing

Wind

enforcement
Enforcement
  • EPA must monitor:
    • Number of permits in possession of each polluter
      • CBOT
    • Quantity of emissions from each source
      • Incentive for polluters to monitor each other to prevent cheating (reduces demand for permits)
incentives for innovation
Incentives for Innovation

$

Cost savings as good as emission taxes

Permit price = $50

$200

MAC1

MAC1 = 200 - 2E1

MAC2 = 100 – E2

MAC2

$100

$50

c

d

a

b

e

TAC with MAC1 = d + e = $625

50

75

100

emissions

TAC with MAC2 = b + e = $1250

Revenue from TDP = b + c = $1250

(d+e) – (b+e) + (b+c) = d + c = $625

Cost Savings =

which of the following is a criterion for evaluating environmental policies
Which of the following is a criterion for evaluating environmental policies?
  • efficiency
  • fairness
  • incentives to improvements
  • enforceability
  • All of the above
private bargaining can lead people to the efficient outcome if
Private bargaining can lead people to the efficient outcome if
  • transactions costs are low and property rights are well defined
  • transactions costs are high and property rights are ill defined
  • transactions costs are high and property rights are well defined
  • transactions costs are low and property rights are ill defined
the two defining features of command and control regulation are
The two defining features of command-and-control regulation are
  • cost-effectiveness and flexible standards
  • pollution taxes and marketable permits
  • uniform standards and technology-based regulations
  • monitoring and compliance
emission taxes are generally regarded as efficient since
Emission taxes are generally regarded as efficient since
  • they raise the maximum amount of revenue possible for the IRS
  • they encourage all pollution sources to completely eliminate their emissions
  • they require environmental regulators to know the individual source marginal abatement
  • they encourage all pollution sources to adjust their emissions so that the equimarginal principle is satisfied.
emission taxes are more likely to be effective when applied to
Emission taxes are more likely to be effective when applied to
  • nonpoint sources of pollution
  • point sources of pollution
slide76

Marketable pollution permits require a slightly more complex system when there are geographic differences in pollution effects. One possible approach to designing a system of permits would be to:

  • use technology-based standards in conjunction with the permits
  • auction off the permits one-by-one over time until all permits have been allocated
  • simply give the permits away to polluters based on their historic emissions rate
  • establish separate markets for each subregion