© 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole...

© 2010 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.

Environmental Economics & Management:

by Scott J. Callan and Janet M. Thomas

Slides created by Janet M. Thomas

Theory, Policy, and Applications 5e

© 2010 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.© 2010 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.

Economic Solutions to Environmental Problems The Market Approach

Chapter 5


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

3


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

5


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. Internalization 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

QE, it is called a Pigouvian tax

6


Selected International Gasoline Tax Rates

Nation Tax Rate % of Price (2008)

United States 18.5

U.K. 67.8

France 67.4

Germany 70.3

Japan 45.8

Spain 56.0

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Source: International Energy Agency, November, 2008


Modeling a Pigouvian Tax

8

$

Q of gasoline

MPB = MSB

MPC

MSC = MPC + MEC

0 QE QC

MPCt

b

a

Amount of tax


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

9


Emission (Effluent) Charge

A fee imposed directly on the discharge of pollution Assigns a price to pollution

Typically implemented through a tax

10


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)

11


Modeling Emission ChargeSingle Polluter

12

$

Abatement (A)0

MAC

MTt

AO AST

a b

c

Firm abates up to Ao sinceMAC < MT; firm pays tax between AO and AST, sinceMAC > MT in that range

0aAO = cost to abate AO

AOabAST = tax on pollutionnot abated up to AST


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

13


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



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.

14


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

15

Modeling An Emission ChargeMultiple Polluter

MAC1 MAC2

0

10

10 0

25.00

6.25

Polluter 1’s Abatement

Polluter 2’s Abatement

2

8

MT = 5.00 MT = 5.00

MAC 1

MAC2

Total Abatement Level = 10 = As

TAC1 + TAC2 = $25 (right triangles)Total Tax Payments = $50 (rectangles)



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

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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

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Assessing the Model (cons)


Pollution Charges in Practice Internationally, the pollution charge is the most

commonly used market-based instrument Australia, Bulgaria, France, and Japan, use fees

or taxes to control noise pollution generated by aircraft

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

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Environmental Subsidies


Environmental Subsidies Two major types of subsidies:

Abatement equipment subsidies Pollution reduction subsidies

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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

22


Pigouvian SubsidyMarket for Scrubbers

23

($ millions)

MSC

MPB

MSB

0 QC = 200 QE = 210

PC = 170

PE = 175 Subsidy = $14 million

MPBS

Q of scrubbers

PE – s = 161

K

L


Assessing the Model

It is difficult to measure the MEB May bias polluters’ decisions about how best to

abate

24


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

25


Assessing the Model

Might be less disruptive than an equipment subsidy—doesn’t influence the technology

Can have the perverse effect of elevating pollution levels in the aggregate since the subsidy lowers unit costs and raises profit, encouraging entry

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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

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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

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Modeling Deposit/Refund SystemIW 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

30

Deposit-Refund Model

$

Improper Waste Disposal (%)

MPBIW = MSBIW

MPCIW

MSCIW

0

QE QIW

MPCIW + Deposit

b

a

Deposit=MEC at Qe

100Proper Waste Disposal (%) 0100

Deposit converts % of overall waste disposal, measured by (QIW - QE), from improper methods to proper



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

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in Michigan, for example, the return rate of containers one year after the program was implemented was 95 percent (Porter 1983);

and in Oregon, littering was reduced and long-run savings in waste management costs were achieved (U.S. General Accounting Office 1990).


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, 11 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

34


Glass container deposit-refund systems are widely used in other OECD countries, including Australia, Austria, Belgium, Canada, Denmark, Finland, Iceland, the Netherlands, Norway, Portugal, Sweden, Germany, Sri Lanka, and Switzerland (OECD 1993a).


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 are1. Fixed number of permits is issued based on an

“acceptable” level of pollution set by government2. The permits are marketable

Bargaining gives rise to a market for pollution rights: cap-and-trade system

37


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

38


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

39


Pollution Permit System





Each firm releases 10 units of pollution, government: acceptable level of pollution: 10 units; 10 permits are issued—5 to each polluter.


Round 1 Polluter 1: current pollution level: 10 units Permits: 5 Abatement required: 5 MAC(1)=2.5(5)=12.50 TAC(1)=1.25(5)sq=31.25 Polluter 2: current pollution level: 10 units Permits: 5; Abatement required: 5 MAC(2)=.625(5)=3.13, TAC(2)=.3125(5)sq=7.81


Round 2: Polluter 2 sells one permit to polluter 1 at price=8

Polluter 1: current pollution level: 10 units Permits: 6; Abatement required: 4 MAC(1)=2.5(4)=10 TAC(1)=1.25(4)sq=20 Cost of 1 permit purchased: 8 Polluter 2: current pollution level: 10 units Permits: 4; Abatement required: 6 MAC(2)=.625(6)=3.75, TAC(2)=.3125(6)sq=8 Revenue from one permit sold: $8


Final round of trading; 3 units traded at P=8, 7 and 5

Polluter 1: current pollution level: 10 units Permits: 8; Abatement required: 2 MAC(1)=2.5(2)=5 TAC(1)=1.25(2)sq=5 Cost of 3 permits purchased: 20 Polluter 2: current pollution level: 10 units Permits: 2; Abatement required: 8 MAC(2)=.625(8)=5, TAC(2)=.3125(8)sq=20 Revenue from 3 permits sold: $20


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

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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), launched in 2005

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