Environmental Policy Instruments

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Environmental Policy Instruments

• EEP 255
• October 21, 2003

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Inefficient vs. Efficient Pollution Abatement
MB
S or MAC
Private Property or Open Access Equilibrium
Efficient Equilibrium
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Externalities

• Costs or benefits that result from market
  activities, but are not reflected in the market
  supply or demand curves (I.e. in the decisions by
  suppliers and consumers).
• Externalities can be positive or negative
• Externalities can arise either from production
  (SMC?PMC) or from Consumption (SMB?PMB)

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Private, Social, and External Costs Without
Abatement
Marginal Social Cost without abatement
Marginal Private Cost without abatement
MB
Marginal External Cost without abatement
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Market Failure in the Private Goods Market
Marginal Social Cost (MSC)
Marginal Private Cost (MPC)
MB
Marginal External Cost (MEC)
Efficient Equilibrium
Inefficient Equilibrium
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Terminology of Externalities

• Marginal Social Benefits (MSB)
• Benefits to market consumers plus benefits(or -)
  enjoyed by individuals external to the market
• Marginal Private Benefits (MPB)
• Benefits enjoyed by market consumers only
• Marginal Social Costs (MSC)
• Costs to market suppliers plus costs borne by
  individuals external to the market
• Marginal Private Costs (MPC)
• Marginal costs borne by market suppliers only

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Negative and Positive Externalities

• MSB MPB MEB (Marginal External Benefit)
• Negative externality occurs when MEB is negative
• Positive externality occurs when MEB is positive
• MSC MPC MEC (Marginal External Cost)
• Negative externality occurs when MEC is positive
• Positive externality occurs when MEC is negative

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Example Effect of Market Failure for Resource
Conservation on Markets for Private Goods

• If the government does not determine the quantity
  of resource conservation, none will be produced.
• If resource conservation is not required, firms
  are free to use natural resources.
• This changes the firms profit functions because
  the price of raw material inputs will depend only
  on the marginal extraction cost.
• Because production costs are lower, the supply
  curve for the firms outputs will shift to the
  right. This is shown in the next two slides.

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Market for Resource Conservation Example of
Stock Size in a Ocean Fishery
MB
MC
Open Access Equilibrium
Efficient Equilibrium
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Market for Harvested Ocean Fish
MSC
MSB
MPC
Efficient Equilibrium
Private Market Equilibrium
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Marginal User Cost in the Market for Harvested
Ocean Fish
MSC
MSB
MPC
Marginal User Cost (MUC)
Efficient Equilibrium
Private Market Equilibrium
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User Cost

• The cost of using an asset today rather than
  saving it for a future use.
• Its an inter-temporal externality
• MSC-MPC MUC (marginal user cost)

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Environmental Policy Instruments

• EEP 255
• October 23, 2003

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Market Failure and Open Access

• Market for environmental quality (abatement or
  resource conservation) fails to form
• If the state does nothing about this market
  failure, there is open access to environmental
  quality
• Open access to environmental resources results in
  an inefficient amount of environmental quality

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Environmental Policies

• Replace open access to the environment with state
  ownership of the environment
• The state determines the amount of environmental
  quality (abatement or conservation) that will be
  supplied (Goal)
• The state determines how environmental quality
  (abatement or conservation) will be supplied and
  who pays for it (Means)

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Fundamental Choices in Environmental Policy

• What is the problem?
• To regulate or not to regulate?
• How much to regulate? Goal setting
• How to achieve the goal? Which policy tool(s)?
• How to monitor and enforce performance?
• What are Federal, state and local
  responsibilities?

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To regulate or not to regulate?

• Property rights and common LawTake the offending
  party to court and get compensated or private
  negotiations
• Defining property rights
• Pollution rarely occurs one to one
• Long latency period
• Information asymmetry
• Valuation difficulties
• Tradeoff between Market Failure and Government
  Failure (bureaucratic, political, technical,
  informational, capacity)

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How much to regulate? Goal setting

• Idealists Zero emissions or zero risk
• Politicians Protect human health with
  adequate/ample margin of safety
• Engineers To the extent technologically possible
  (best technology)
• Economists Where marginal social
  benefit()marginal social cost()
• US POLICY IS A HYBRID OF ALL THESE

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The Economic Question About Ambient Air Quality
Standards
What is the economically efficient
standard? Answer Where Marginal benefit(MB)
Marginal cost
of abatement (MAC)
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The Efficient Ambient Standard
Efficient Ambient Standard
Demand for abatement (MB)
Supply of abatement (MAC)
?g/ m3 Emitted
Open Access
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Which policy tool(s)?

• 1. Centralized command and control
• Equal reduction
• Unequal based on affordability
• Specific control technology (say FGD)
• Specific performance (RFG rules)
• Least cost (unequal across sources)

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Which policy tool(s)?

• 2. Decentralized market incentives
• Pollution taxes/effluent charges
• Subsidies (control equipment or emission)
• Tradable permits (allowances, credits)
• Information disclosure (TRI)
• 3. Moral suasionVoluntary programs and
  agreements (33/50, XL, Energy-star, ISO 14000)
• 4. Direct government provision (public lands,
  clean-up, sewage treatment, clean technology RD)

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How to monitor and enforce performance?

• Permits for emissions
• Monitoring systems
• self audit
• third party audit
• agency inspection
• Record keeping and reporting regulations
• Monetary fines
• Criminal penalties

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Two Types of Environmental Policies

• Policies that establish an environmental quality
  goal for a particular geographic area (Amount of
  environmental quality to supply)
• Policies that establish the means by which the
  environmental policy goal will be achieved (How
  environmental quality will be supplied)

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Example Air and Water Quality Policies

• Ambient Standards (Goal)
• Implementation Policies (Means)

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Ambient Standards for Air and Water Quality

• Air quality standards
• National ambient air quality standards (NAAQS)
• National emissions standards for hazardous air
  pollutants (NESHAP)-Technology based emission
  standards
• Water quality standards
• Use designation for all water bodies (e.g.,
  swimable, fishable, boatable, commercial)
• Water quality criteria set to meet the designated
  use

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Criteria Pollutants and NAAQS

• Common pollutants with widespread effects
• Particulate matter(PM) aggravation of
  respiratory and cardiovascular symptoms, damage
  to lungs, carcinogenic material damage, soiling,
  visibility (50µg/m3-PM10, 15µg/m3-PM2.5)
• SO2 aggravation of respiratory and
  cardiovascular symptoms, damage to lungs, acid
  rain, corrosion (80µg/m3)
• COvision impairment, loss of work capacity,
  dexterity(9ppm)
• NOx Lung irritation, reduced resistance,
  respiratory disease(100µg/m3)
• Tropospheric OzoneReduced lung function,
  damage,higher sensitivity reduced crop yields,
  leaf damage,ecosystem damage (0.12ppm)
• Lead Kidney,liver damage, nervous system damage
  in children, increased blood pressure and heart
  disease(1.5µg/m3)

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An Example of an Ambient Air Quality Standard

• Sulfur dioxide SO2 in air
• Annual average daily concentration 80?g/ m3
• 24-hour average concentration 365?g/ m3
• Carbon Monoxide 8 and 1 hour average
  concentrations 10?g/ m3 and 40?g/ m3 resply.
• Hazardous Air Pollutants (HAPs) eg. Coke oven
  gas, Benzene, (89 listed)

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Implementation Policies for Achieving Ambient Air
Quality Standard

• Emissions Standard
• Abatement Technology Standard
• Emissions Tax
• Marketable Emissions Permit
• Input and Output Taxes Subsidies

Direct policies
Indirect policies
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The Economic Question About Policies for
Implementing Air Quality Standards
What is the most cost-effective implementation
policy?
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Uniform Emissions Standard
EmissionsStandard
MAC2
MAC1
Firm 1 abates 5 and Firm 2 abates 5
Combined MAC
Total cost 35 (12.522.5)
Actual Emissions
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Emissions Tax
MAC2
MAC1
Firm 1 abates 6 (emits 4) and Firm 2 abates 4
(emits 6)
EmissionsTax
Total abatement cost 34 (1618)
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Tradable Emission Permit

• Government (EPA) decides on total allowable
  emissions
• Issues tradable emission permits
• May sell them or allocate them on some criteria
  (grandfathering)
• Firms are required to have permits equivalent of
  their emissions.
• If firms have excess permits because they reduced
  emissions below the allocated permits, they can
  sell excess permits in the market to others who
  could not reduce emissions.

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Example Permits Market

• Assume 2 firms with MAC functions as before.
• Assume each firm currently emits 10 tons
• EPA issues total 10 permits divided equally
  between the two firms (5 each)
• If no trading occurs total cost12.522.535
• How much does it cost for firm 1 to reduce one
  more ton of emissions? say 5.5 avg
• How much does Firm 2 save if it emits one more
  ton say 6.5 avg
• Firm 2 might be willing to buy one permit for
  pricelt6.5 and Firm 1 might be willing to sell 1
  permit for pricegt5.5
• Market results in 10 ton reduction with firm 1
  abating 6 (emitting 4) and firm 2 abating only 4
  (emitting 6) with firm 2 buying one permit from
  firm 1 at a price of approximately 6
• Total (societal) abatement cost 34 (instead of
  35)

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Marketable Permit
MAC2
MAC1
Firm 1 abates 6 (emits 4) and Firm 2 abates 4
(emits 6)
Permit Price
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Effect of Abatement on Firms Output
S
S'
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When Emissions Cannot Be Monitored

• Tax Outputs of Production
• Higher abatement costs because the only abatement
  alternative is to supply less of the output
• Tax Inputs to Production
• Higher abatement costs because the only abatement
  alternative is to use less of the input

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Negative Externality in Supply of an Output
(e.g., Electricity, Petroleum)
MSC
MPC
MSB
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Output Tax Marginal Private Costs minus Marginal
Social Costs
MSC
MPC
MSB
TAX 2
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Output Tax Amount of the Tax
MSC
MPC
MSB
TAX 2
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Output Tax Buyer and Seller Prices
MSC
MPC
MSB
Buyers Price 5
Suppliers Price 3
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Output Tax Government Revenue
MSC
MPC
MSB
Buyers Price 5
Govt Revenue 2 x 2
Suppliers Price 3
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Effect of Input Tax on Supply of an Output
S
S
MSB
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Resource Conservation Policies

• Taxing resource use
• Subsidizing resource conservation

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Other policy instruments

• Property rights and common LawTake the offending
  party to court and get compensated or private
  negotiations
• Defining property rights
• Pollution rarely occurs one to one
• Long latency period
• Information asymmetry
• Valuation difficulties
• Moral suasion
• Information disclosure (TRI, Labeling)
• Voluntary programs and agreements (33/50, XL,
  Energy-star, ISO 14000)
• Direct government provision (public lands,
  clean-up, sewage treatment, clean technology RD)