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Econ 201 Chpt 10 . Summary: Taxes, Standards and Tradable Permits. Remedies for Negative Externalities. Standards Permissible level of emissions for each factory in an industry (each industry gets same target), or

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Econ 201 chpt 10

Econ 201Chpt 10

Summary: Taxes, Standards

and Tradable Permits

Remedies for negative externalities
Remedies for Negative Externalities

  • Standards

    • Permissible level of emissions for each factory in an industry (each industry gets same target), or

    • Targets how much emissions must be reduced by each factory (again, same target for all)


    • Direct tax on emissions

      • Indirect on input/output if there is a direct correlation between input/output and pollution

        • E.g., tax on gasoline, coal based on sulfur content

  • Tradable permits

    • Gives each firm the “right” to pollute to a certain level

    • Firms are allowed to trade/sell permits

Two big questions
Two Big Questions

  • What is the optimal level of pollution?

  • How should it be allocated among its sources (firms)?

How do we set the standard
How Do We Set the Standard?

Equate MC of damage

To MC of abatement

Comparing standards
Comparing Standards

  • Essentially all 3 approaches can theoretically be set to achieve an optimal standard

    • MC[damages] = MC[abatement]

  • In practice

    • Hard to obtain accurate data on damages

    • Standards have been set arbitrarily in all 3 cases

Evaluating the efficiency of allocation
Evaluating the Efficiency of Allocation?

  • Economic Efficiency

    • Does the policy result in meeting the standard in a least-cost manner?

  • Administrative Cost Efficiency

    • What are the monitoring, enforcement and other administrative costs?

  • Flexibility: responding to changes in market dynamics, e.g., inflation, changes in demand?

    • Self-adjusting or not?

Comparison of approaches
Comparison of Approaches

  • Standards

    • Can produce optimal level of pollution

      • But setting same standard for all firms (and are not productively efficient, e.g. min cost)

      • To set individual quotas: requires knowledge of each firm’s costs

      • Provide no incentive for firms to reduce pollution below current “authorized” levels

    • Have higher administrative costs

      • Not only have to monitor emissions

      • Enforcement costs: legal proceedings (time delays and expense)

      • Not very flexible: regulatory process for changing standards

    • Can not respond easily to changes in market conditions

      • Require rewriting legislation, establishing new standards

Comparison of approaches1
Comparison of Approaches

  • Standards

    • Are most useful when:

      • Problem is short-lived (“burn” bans for high pollution days)

      • Optimal level is zero

Comparison of approaches2
Comparison of Approaches

  • Taxes

    • Can produce “optimal” amount of pollution at minimum costs and lower administrative costs

      • Kneese (1977): comparing taxes versus standards found that desired quality costs half as much using taxes

    • Automatically allocates pollution levels among firms based on their costs

      • Provides incentive for firms to reduce pollution levels through technological innovation

    • Easy to adjust/”tune” to “right” level

      • But does not respond without change to tax rate

    • Tax revenues can be used finance admin costs

Cost savings from charges versus standards
Cost Savings from Charges versus Standards


Firm 2

Lower Costs

Comparison of approaches3
Comparison of Approaches

  • Tradable Permits

    • Cost efficient

      • Firms will purchase permits from more efficient firms if permit cost < abatement (technology) costs

    • Technological incentive to reduce pollution

      • Marginal cost of abatement = permit cost

        • Similar to taxes

    • Administratively simpler

      • Require less information about the firms’ cost

      • Better able to handle “spatial” variation in pollution

        • Fewer permits auctioned in bad areas

      • Adjust “automatically” for changes in inflation and growth

        • E.g., Ca RECLAIM experience

    • If auctioned -> revenues for admin costs

A webinar on tradable permits
A Webinar on Tradable Permits