Econ 150 Notes 4 - Professor: Derek Lemoine PDF

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Professor: Derek Lemoine...

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Lecture Notes

ECON 150 C1

Unit 4

Pollution Policy o Part 1: Optimal Pollution  Takeaway: We seek to maximize net benefits: it is optimal to emit pollution up to the point at which the last unit causes more damage than it would cost to eliminate it  Recall that marginal benefit is the additional benefit from the next unit of something  What’s the benefit from the first unit of pollution?  How much benefit does the next unit bring?  Does marginal benefit rise or fall as we emit more?  Abatement means reducing emissions  What’s the cost of the first unit of abatement?  How much does the next unit cost?  Does marginal abatement cost rise or fall as we abate more?  A lot of abatement means little pollution

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Recall that marginal cost is the additional cost from the next unit of something  What goes into the cost of pollution?  What do companies consider?  What should policymakers consider?  Is the cost of the first unit high or low?  Does the cost of 1 more unit of pollution rise or fall as we get more pollution?

Lecture Notes

ECON 150 C1

Unit 4

Lecture Notes

ECON 150 C1

Unit 4

o Part 2: Property Rights  Takeaway: The Coase Theorem says that it doesn’t matter who has property rights so long as somebody has them. But part of its point is that it doesn’t apply to may environmental challenges  Need to compare the value of the pollution between the polluter and the people affected by it and find the optimal level of pollution altogether  The polluter obviously values the pollution highly and the ones affected obviously value it lowly and thus value no pollution highly – but somewhere in the middle there is a combined value that is higher than either end.  The Coase Theorem applies when it is easy to negotiate and easy to assign clear property rights  In that case, market mechanisms can solve many externality problems if backed by a strong legal system. We don’t need further policy.  Further, the efficient level of the externality occurs regardless of which party gets the property rights

Lecture Notes

ECON 150 C1

Unit 4

Who gets those rights does determine who makes more money, but not the quantities made  Again: The Coase Theorem applies when it is easy to negotiate and easy to assign clear property rights…why might this not apply to many environmental problems?  1. High transaction costs (the cost of buying/selling beyond the actual price paid  E.g. on coal plant and a million nearby citizens  Property rights might be hard to define and enforce  How do you divide up the air and stop people from breathing other people’s air?  Imperfect Information  Is your cancer definitely caused by that power plant? What if it went bankrupt in the meantime? Is that hurricane definitely caused by your carbon emissions? o Part 3: Policy Options  Takeaway: Getting rid of pollution in the cheapest manner is easiest if we use emission taxes or a cap-and-trade program so companies can decide for themselves how much to emit  Our goal is not just to get to the optimal level of pollution but to get there in the cheapest manner  Some pollution sources find it cheaper to reduce emissions than others. Think of gas plants vs. coal plants vs. cars  This would be easy if the government knew every company’s cost of reducing emissions  Imagine you produce one unit of pollution  Your birthday (day of month) is your cost of getting rid of it  Each unit of pollution causes $15 of damage  What is the optimal level of pollution? o If there are 180 of people in the class, and 50% with birthdays above the 15th and half below, each emitting one unit, then the optimal level of pollution is 90 units. People with a cost below $15 should get rid of pollution and people with a cost above $15 should keep their pollution. o Command-and-Control – when a pollution policy tells firms to do something in particular  Input Standard: Restrict the use of an input to production  Technology (or process) Standard: Require some specific technology or process  How firms must clean up and with what technology  Emission Standard: Require all sources to emit less than some level  A requirement for every firm – no requirements on how the firm gets below the level of pollution emissions – just do it  Ambient Standard: Require that pollution fall below some limit  More focus on the market as a whole – least restrictive policy 

Lecture Notes

ECON 150 C1

Unit 4

o Market-based Instrument – In contrast to C-and-C, it sets up a pollution market and lets each firm decide for itself what to do  Remember our earlier discussion of what prices do. The goal is to get prices right.  First, a pollution tax makes each firm pay a set price per unit of pollution  What do firms do in response?  What tax should I set to reduce our class pollution to the optimal level?  There are market-based instruments other than taxes  Second, I can use an abatement subsidy: I can pay you to reduce your emissions  How much should I pay you?  A third market-based instrument is to give firms pollution rights  I can set up a cap-and-trade (or tradable permit) program: I’ll issue permits, and you’re free to trade them among yourselves  In terms of who pollutes, it didn’t matter whether I auctioned the permits or how I have them away  This is like the Coase Theorem result  Economists have favored market-based instruments for decades. In the last 20 years, we’ve begun to see them used more.  The U.S Acid Rain Program is the signature cap-and-trade success story  Actual costs of reducing emissions were much less than projected, in part because firms had the freedom to figure out the cheapest ways to get there  Cap-and-trade has been applied to greenhouse gases as well Misc. Presentations o Misc. Presentation 1: European Union - Key Points  The European Union has a Cap-and-Trade system  Give out an amount of permits that appears ideal and expect to see a certain level of pollution as a result  Three Phases  1: Permits were handed out, not too strict enforcement, market crashed in 2006 because price of carbon permit went to zero  2: Goals/Standard being met (but not due much to program), prices remained extremely low, no real innovation/investment in environmentally efficient technologies  A fix could be to put a price floor on permits  3: Cap is now EU wide, auctioning is now the default way of permit allocation  Takeaways  Goal is to reduce emissions from firms by 43% by 2030  No goal for reducing individual’s emissions  As of now, there is no incentive to implement new, cleaner and more efficient technology – firms are just cutting costs and increasing prices –this is not the goal of a cap-and-trade program

Lecture Notes

ECON 150 C1

Unit 4

o Misc. Presentation 2: Acid Rain – Key Points  Acid Rain is caused when emission of sulfur dioxide and nitrogen oxides react In the atmosphere to form various acidic compounds  Detrimental Effects  Impair air quality, damage public health, acidify lakes, harms ecosystems, etc.  Problems  Market failure  Failure 3: Externalities  Solution Program  Market based policy  Cap-and-trade system  EPA issues fixed number of allowances  Only one ton of SO2 to be emitted per allowance  Results  Incentives for innovation and diffusion  TO REMEMBER:  1st example of cap-and-trade in large scale and was successful  Thought cost of policy would be high but firms realized that instead of paying a lot to buy a scrubber they began to buy sulfur from Wyoming and beat the policy while still achieving the policy’s goal essentially  Mercury is local unlike carbon dioxide – policy needs to consider areas downwind of plants that have permits o Misc. Presentation 3: Clean Air Policy – Key Points  EPA really wants to choose to work together and have a national market...