Lect 4a

ECONOMIC SOLUTIONS TO
ENVIRONMENTAL PROBLEMS
THE MARKET APPROACH
 Chapter 5
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Overview
 Market approach refers to incentive-based policy that
encourages conservative practices or pollution reduction
strategies
 Difference between market approach and command-and-control
approach is how each approach attempts to achieve its
objectives
 Types of Market Instruments
 Pollution charge
 Subsidies
 Deposit/refund systems
 Pollution permit trading systems
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 2
Pollution Charges
Pollution Charge
 Fee that varies with amount of pollutants
released
 Based on “Polluter-Pays Principle”
 Types of pollution charges
 Effluent/emission fees
 Product charge
 User charge
 Administrative charge
Product Charge
 Fee added to price of pollution-generating product,
which generates negative externality
 Impose product charge as per unit tax on
product, e.g., gas tax
 How does the tax on gasoline in the US compare with
that of other nations?
 If the tax equals the marginal external cost (MEC) at Q E,
it is called a Pigouvian tax
Selected International Gasoline Tax Rates
Nation Tax Rate % of Price
(2011)
United States 13.2

U.K. 61.6
France 58.1
Germany 60.5
Japan 45.8
Spain 50.1
Source: International Energy Agency, January 2011

Modeling a Pigouvian Tax
$
MSC = MPC + MEC
MPCt
MPC
a
Amount of tax
b
MPB = MSB
0 QE QC Q of gasoline7
Assessing the Model
 In theory, achieves an efficient outcome

 In practice, difficult to identify the value of
MEC at QE
 Allows only for an output reduction to reduce
pollution
Emission (Effluent) Charge
 A fee imposed directly on the discharge of

pollution
 Assigns a price to pollution
 Typically implemented through a tax
Model: Single Polluter Case
 Government sets an abatement standard at AST
 Policy options to polluter are:
 Abate up to AST and incur those costs OR
 Pay a constant per unit tax, t, on any abatement less than
AST
 Total Tax = t(AST - AO)
 where AO is actual abatement level
 Marginal Tax (MT) = t
 Because t is constant, t = MT
 Firm will choose the least-cost option: the marginal
tax (MT) or the marginal abatement cost (MAC)
Modeling Emission Charge
Single Polluter
$ Firm abates up to Ao since

MAC < MT; firm pays tax
MAC
between AO and AST, since
MAC > MT in that range
0aAO = cost to abate AO
c AOabAST = tax on pollution
not abated up to AST
a b MT
t
0 AO AST Abatement (A)

Model: Multiple Polluter Case
 To facilitate comparison, we use the same model

as in the uniform standard case
 Assumptions
 2 polluting sources in some region
 Each generates 10 units of pollution
 Government sets emissions limit for region as 10
units, which implies AST = 10
 Policy: To achieve AST, government imposes an
emission charge as a unit tax (t) of $5
Model: Multiple Polluter Case
 Each firm responds as in the single polluter case
 Abates as long as MAC < MT
 Pays emission charge when MAC > MT
 Polluter 1: TAC1 = 1.25(A1)2

MAC1 = 2.5(A1)
 where A1 is pollution abated by Polluter 1
 Polluter 2: TAC2 = 0.3125(A2)2
MAC2 = 0.625(A2)
 where A2 is pollution abated by Polluter 2
 Find each firm’s abatement level. Then, find each firm’s
total abatement costs (TAC) and tax payment at that
level. Support with a graph.
Solution
 Polluter 1:
 Abates up to the point where MAC1 = MT,
 Set 2.5(A1) = $5, or A1 = 2
 Incurs TAC1 = 1.25(2)2 = $5
 Incurs Total Tax = 5(10 - 2) = $40
 Polluter 2:
 Abates up to point where MAC2 = MT
 Set 0.625(A2) = $5, or A2 = 8
 Incurs TAC2 = 0.3125(8)2 = $20
 Incurs Total Tax = 5(10 - 8) = $10
Modeling An Emission Charge
Multiple Polluter
MAC1 MAC2
Total Abatement Level = 10 = AST
25.00
TAC1 + TAC2 = $25 (right triangles)
Total Tax Payments = $50 (rectangles)
C1
MA
6.25
MT = 5.00 MT = 5.00
MAC
2
0 2 10
Polluter 1’s Abatement
10 8 Polluter 2’s Abatement 0

Assessing the Model (pros)
 Abatement standard is met
 Generates $40 in tax revenues from high-cost
abater and $10 from low-cost abater
 Low-cost abaters do most of cleaning up
 Cost-effective solution is obtained
 MACs are equal at $5 tax rate
 Combined TAC of $25 is lower than $39.06 under
command-and-control with a uniform standard
Assessing the Model (cons)
 Tax authority will not know where MACs are equal
 Will have to adjust rate until objective achieved
 Monitoring costs potentially higher

 Firms might evade tax by illegally disposing
pollutants
 Distributional implications
 Consumers may pay higher prices due to tax
 Job losses may result from polluter paying new taxes
and/or changing technology to abate
Pollution Charges in Practice
 Internationally, the pollution charge is the most
commonly used market-based instrument
 Australia, France, Germany, and Japan use fees or
taxes to control noise pollution generated by aircraft
 Canada, France, Mexico, and Poland are among the
nations using effluent charges to protect water
resources.
 Others levy charges on products such as batteries, tires,
lubricant oil, packaging, paint, paint containers, and
gasoline
Environmental Subsidies
Environmental Subsidies
 Two major types of subsidies:

 Abatement equipment subsidies
 Pollution reduction subsidies
Abatement Equipment Subsidy
 Defined as a payment aimed at lowering the cost
of abatement technology
 Goal is to internalize the positive externality associated
with the consumption of abatement activities
 If the subsidy (s) equals the marginal external
benefit (MEB) at QE, it achieves an efficient
equilibrium and is called a Pigouvian subsidy
Pigouvian Subsidy
Market for Scrubbers
($ millions)
MSC
K
PE = 175 Subsidy = $14 million
PC = 170
PE – s = 161 L MPBS
MSB
MPB
0 QC = 200 QE = 210 Q of scrubbers
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22
Assessing the Model
 It is difficult to measure the MEB

 May bias polluters’ decisions about how best to
abate
Pollution Reduction Subsidy
 To implement, government pays the polluter a

subsidy (s) for every unit of pollution abated
below some pre-established level ZST
 Per unit subsidy = s(ZST - ZO), where ZO is the
actual level of pollution
 Analogous to an emission charge
Assessing the Model
 Might be less disruptive than an equipment

subsidy
 Can have the perverse effect of elevating
pollution levels in the aggregate since the
subsidy lowers unit costs and raises profit,
encouraging entry
Subsidies in Practice
 Environmental subsidies typically are implemented as
grants, low-interest loans, tax credits or exemptions,
and rebates
 Many countries around the world use these
instruments, including Belgium, Denmark, Finland,
Japan, and Turkey
 In the U.S., common uses include federal funding to
build publicly-owned treatment works and subsidies to
encourage the development of cleaner fuels and low-
emission vehicles
Deposit-Refund Systems
Deposit/Refund Systems
 A deposit/refund system is a market

instrument that imposes an up-front charge
to pay for potential damages and refunds it
for returning a product for proper disposal
or recycling
 Targets the potential vs. actual polluter
 The deposit is intended to capture the MEC of
improper waste disposal (IW) in advance
 Preventive vs. ameliorative
Modeling Deposit/Refund System
IW disposal market
 MECIW: health damages + aesthetic impairment

from litter, trash accumulation, etc.
 MPCIW: costs to disposer (e.g., trash receptacles,
collection fees, plus forgone revenue from not recycling)
 MSCIW = MPCIW + MECIW
 MPBIW: demand for improper disposal
 Assume MEBIW = 0, so MPBIW = MSBIW
Deposit-Refund Model
$ Deposit converts % of overall waste
disposal, measured by (QIW - QE), MSCIW
from improper methods to proper
MPCIW + Deposit
MPCIW
a
Deposit=MEC at Qe
b
MPBIW = MSBIW
QE QIW
0 Improper Waste Disposal (%) 100
Proper Waste Disposal (%) 0
100
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Assessing the Model
 Promotes responsible behavior

 Requires minimal supervision by government
 Can help slow the use of virgin raw materials
by improving availability of recycled materials
Deposit/Refund Systems in Practice
 Deposit/refund systems are used worldwide

 Many nations use these systems to encourage
proper disposal of beverage containers
 In the US, 10 states have bottle bills
 Deposits range from 2 cents to 15 cents per
container
 Other applications include systems used to
promote responsible disposal of used tires,
car hulks, and lead-acid batteries
Pollution Permit Trading Systems
Pollution Permit Trading Systems
 A pollution permit trading system establishes a

market for rights to pollute by issuing tradeable
pollution credits or allowances
 Credits are issued for emitting below a standard
 Allowances indicate how much can be released
 Two components of the system are
1. Fixed number of permits is issued based on an
“acceptable” level of pollution set by government
2. The permits are marketable
 Bargaining gives rise to a market for pollution rights
How Permit Trading Works
 There is an incentive to trade as long as
polluters face different MAC levels
 Suppose a firm has 50 permits but normally
emits 75 units of SO2. What must it do?
 Answer
 Abate 25 units of emissions OR
 Buy 25 permits from another producer
 Which option will the firm choose?
 Answer
 Whichever option is cheaper
Result
 Low-cost abaters will clean up pollution and sell
excess permits to other firms
 They will sell at any P higher than their MAC
 High-cost abaters will buy permits rather than abate
 They will buy at any P lower than their MAC
 Trading will continue until the incentive to do so no

longer exists, at which point, the cost-effective solution
is obtained, i.e., the MACs across firms are equal
Assessing the Model
 Trading establishes the price of a right to

pollute without government trying to “search”
for a price
 No tax revenues are generated
 Trading system is flexible
 Note that an emissions standard can be adjusted
by changing the number of permits issued
Pollution Trading Systems in Practice
 Most of the evolution of trading is occurring in U.S.
 An important example is the
allowance-based trading program to control sulfur
dioxide emissions under the Clean Air Act Amendments
of 1990
 More innovation has occurred at state and local levels
 Ozone Transport Commission in the Northeast
 California Regional Clean Air Incentives Market (RECLAIM)
 Key international example
 Trading of greenhouse gas allowances are part of the
Kyoto Protocol, an international accord aimed at global
warming
 Includes the European
Union Greenhouse Gas Emission Trading System (EU ETS
) Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
© 2013 Cengage Learning. All Rights 38
, launched in 2005

Lect 4a

Uploaded by

Copyright:

Available Formats

Lect 4a

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Lect 4a

Uploaded by

Copyright:

Available Formats

ECONOMIC SOLUTIONS TO

United States 13.2

Source: International Energy Agency, January 2011

 In theory, achieves an efficient outcome

 A fee imposed directly on the discharge of

$ Firm abates up to Ao since

0 AO AST Abatement (A)

 To facilitate comparison, we use the same model

 Polluter 1: TAC1 = 1.25(A1)2

10 8 Polluter 2’s Abatement 0

 Monitoring costs potentially higher

 Two major types of subsidies:

0 QC = 200 QE = 210 Q of scrubbers

 It is difficult to measure the MEB

 To implement, government pays the polluter a

 Might be less disruptive than an equipment

 A deposit/refund system is a market

 MECIW: health damages + aesthetic impairment

 Promotes responsible behavior

 Deposit/refund systems are used worldwide

 A pollution permit trading system establishes a

 Trading will continue until the incentive to do so no

 Trading establishes the price of a right to

You might also like