Micro-Economie Topic 10 Environmental Protection. Externalities and Public Goods/Bads Pollution – the bargaining solution Policy alternatives for pollution control Who pays for pollution control? Is pollution control bad for business?.
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An externality occurs when an activity generates unintended effects on others for which no payment or compensation is made.
Externalities arise because of the absence of private property rights – if they existed payment/compensation would occur. They are an example of market failure.
Externalities may be beneficial or harmful
In the absence of corrective policy, the level of an activity that gives rise to a harmful/beneficial externality will be too high/low.
External effects often have the characteristics of public goods/bads.
All of these externalities are non-rivalous and non-excludable
2. The effect is Public
Although the Coase analysis is not very helpful in regard to Q2, it does provide the answer to Q1. The efficient level of pollution is where marginal cost equals marginal benefit.
With uniform taxation across discharge sources, the overall reduction is achieved at least cost
MNPB is Marginal Net Private Benefit = MPB – MPC
No tax - Profit maximised where MNPB = 0
With tax – Profit maximised where MNPB = t
Total Cost of pollution reduction = aP1*P1t + bP2*P2t
There is no re-allocation of pollution reduction as between the two firms that can reduce the total cost
There is a problem with emissions taxation – if the firms’ MNPB(P) functions are not known, it is not possible to calculate the tax rate that will bring about the desired overall reduction in pollution. Whatever reduction is achieved will be brought about at least cost, but it could be too big or too small.
Tradeable permits avoid this problem. Since the quantity of permits issued is equal to the desired level of total emissions, assuming compliance, the achieved reduction is that intended. Tradeable permits are dependable, as well as least cost. They have the least cost property because with a single market price per permit, all firms move to where their MNPB = permit price, and the situation is as in the previous slide.
If the permits are initially issued free, there is no revenue arising, as there is with taxation.