BOD Removal, Costs of US Regulations

3. BOD Removal, Costs of US Regulations Source: Magat et al (1986); units: dollars per kilogram BOD removed

4. BOD Removal, Costs of US Regulations Why does this table disturb economists? Source: Magat et al (1986); units: dollars per kilogram BOD removed

5. P Marginal Abatement Cost Curve MAC Abatement

6. P Marginal Abatement Cost Curve: What is the optimal level of abatement? MAC Abatement

7. P Marginal Abatement Cost and Benefit MAB MAC Abatement

8. P Marginal Abatement Cost and Benefit: MAB MAC P* Abatement A*

9. P Marginal Abatement Cost and Benefit: What is the total cost of abatement at A*? What is the total benefit of abatement at A*? MAB MAC P* Abatement A*

10. P Marginal Abatement Cost and Benefit: If there are only two firms, who should abate and by how much? MAB MAC P* Abatement A*

11. P Marginal Abatement Cost and Benefit: If there are only two firms, who should abate and by how much? (A*/2)? MAB MAC P* Abatement A*

12. Society’s marginal abatement cost curve simply reflects the abatement costs of all the individual polluting firms. P MAC1 MAC2 Abatement

13. MAC is the horizontal sum of the individual firms’ abatement cost curves. P MAC1 MAC2 MACs Abatement

14. When there are many firms (not just two) the societal (aggregate) MAC tends to be a smooth upward sloping curve P MAC1 MACs MAC2 Abatement

15. When there are many firms (not just two) the societal (aggregate) MAC tends to be a smooth upward sloping curve How much should each firm abate? P MAC1 MAC2 Abatement A*

16. When there are many firms (not just two) the societal (aggregate) MAC tends to be a smooth upward sloping curve. Does it make any sense to have Firm 1 abate at all? P MAC1 MAC2 MACs P* Abatement A*

17. P MAC for three firms. How much should each abate? MAC1 MAC2 MAC3 Abatement

18. P Deriving the societal (aggregate) marginal abatement cost curve. MAC1 MAC2 MACs MAC3 Abatement

19. P Societal (aggregate) abatement cost curve How much should society abate? MACs Abatement

20. P Marginal societal abatement cost and benefits curves MABS MACs Abatement

21. P Optimal level of abatement at A* How much should each firm abate? MABS MACs P* Abatement A*

22. P Optimal level of abatement at A* How much should each firm abate? MAC1 MAC2 P* MAC3 Abatement A*

23. P Determining optimal abatement for each firm - A1 + A2 + A3 = A* MAC1 MAC2 MACs MAC3 P* Abatement A2 A1 A3 A*

24. P Determining optimal abatement for each firm - A1 + A2 + A3 = A* What is true about the MAC of each firm at those levels? MAC1 MAC2 MACs MAC3 P* Abatement A2 A1 A3 A*

25. P Determining optimal abatement for each firm - A1 + A2 + A3 = A* What is true about the MAC of each firm at those levels? MAC1 = MAC2 = MAC3 = MACS => Equimarginal Condition MAC1 MAC2 MACs MAC3 P* Abatement A2 A1 A3 A*

26. P Determining optimal abatement for each firm - A1 + A2 + A3 = A* What is true about the MAC of each firm at those levels? MAC1 = MAC2 = MAC3 = MACS => Equimarginal Condition What if that condition did not hold? MAC1 MAC2 MACs MAC3 P* Abatement A2 A1 A3 A*

27. P Optimal level of abatement at A* at MAC P* How would a tax, subsidy or marketable allowance program work? MAC1 MAC2 P* MAC3 Abatement A*

28. Economists’ Conclusions 1-3: • The equimarginal condition is a necessary (but not sufficient) condition for allocative efficiency. • Allocative efficiency will be enhanced by using policy instruments that lead to an equimarginal outcome relative to those that do not. • Taxes, marketable allowances, and subsidies can lead to an equimarginal outcome. • Incentive-based instruments lead to dynamic as well as static efficiency

29. Economists’ Conclusions 1-3: • The equimarginal condition is a necessary (but not sufficient) condition for allocative efficiency. • Allocative efficiency will be enhanced by using policy instruments that lead to an equimarginal outcome relative to those that do not. • Taxes, marketable allowances, and subsidies can lead to an equimarginal outcome. • Incentive-based instruments lead to dynamic as well as static efficiency Now let’s move on to public finance issues.

30. Unadulterated market P S P* D Q* Q

31. Unadulterated market What effect would an excise (unit) tax have on P and Q? P S P* D Q* Q

32. Effect of tax, T S’ P T S P* D Q* Q

33. Effect of tax, T What is the new P, Q? S’ P T S P* D Q* Q

34. Consumers pay P’ per unit and receive Q’ S’ P T S P’ P* D Q’ Q* Q

35. Consumers pay P’ per unit and receive Q’ How much of P’ do producers keep after the tax? S’ P T S P’ P* D Q’ Q* Q

36. Consumers pay P’ per unit and receive Q’ Producers keep P’ – T = P” per unit S’ P T S P’ P* P” D Q’ Q* Q

37. Consumers pay P’ per unit and receive Q’ Producers keep P’ – T = P” per unit What is the government revenue? S’ P T S P’ P* P” D Q’ Q* Q

38. Government revenue, R = T x Q’ S’ P T S P’ P* P” D Q’ Q* Q

39. Government revenue, R = T x Q’ What happens to consumer and producer surplus? S’ P T S P’ P* P” D Q’ Q* Q

40. Loss of consumer surplus Loss of producer surplus S’ P T S P’ P* P” D Q’ Q* Q

41. Loss of consumer surplus Loss of producer surplus How much went to tax? S’ P T S P’ P* P” D Q’ Q* Q

42. Loss of consumer surplus Loss of producer surplus S’ P T S P’ P* P” D Q’ Q* Q

43. Loss of consumer surplus Loss of producer surplus What happened to the rest? S’ P T S P’ P* P” D Q’ Q* Q

44. Deadweight loss (Harberger’s triangle) S’ P T S P’ P* P” D Q’ Q* Q

45. Economists’ Conclusions 5-7: • Taxes on goods and services drive a wedge between price and marginal cost creating deadweight loss. • It is better to use environmental policy instruments that do not require new taxes (i.e., avoid subsidies). • It is better still to use environmental policy instruments that raise revenue without distorting prices (i.e. use environmental taxes or auctioned allowances for pollutants that the government is going to control anyway). • Corollary: tax regulated bads, not goods

46. Questions on Stavins (2003): • Which four policy instruments does Stavins discuss? • How does Stavins say the government should determine the level of an environmental tax? What informational and distributional challenge(s) does this raise? • What does Stavins mean by “normative” lessons? • What criteria does Stavins use to evaluate the relative attractiveness of various policy instruments? What characteristics does he suggest are most important? • What does Stavins mean by “using absolute baselines, not relative ones” (p.8) in the design of policy programs? Why does he suggest this? • Why is transparency important for implementation of environmental policy? • How does Stavins introduce the issue of public finance into the discussion? What does he conclude? • What does Stavins mean when he refers to a “hot-spot”? • Does Stavins help us begin to answer our big question in the this class, i.e., why has the economists’ prescription for incentive-based instruments shown up more in practice?