Ch 17 externalities and the environment micro econ4

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Chapter 17 ECON4 William A. McEachern

1

Externalities

and the

Environment





Resources

• Exhaustible resource

– A resource in fixed supply

• Renewable resource

– A resource that regenerates itself

– Can be used indefinitely if used

conservatively

2





Renewable Resources

• Open-access resources

– Rival in consumption and nonexclusive

– Subject to the common-pool problem

– No private property rights

– Negative externalities arise

3





Renewable Resources

• Common-pool problem

– People exploit a resource

• Personal marginal benefit > personal

marginal cost

– Personal marginal cost

• Ignores costs imposed on others

4





Resolving Common-Pool Problem

• Government regulation

– Output restrictions

– Taxes

– Use resource: socially optimal rate

– Improve allocative efficiency

5





Optimal Level of Pollution

• External costs with fixed technology

– Fixed-production technology

• Cut emissions: cut production

– Marginal social cost

• Marginal private cost

• Marginal external cost

6






• Socially efficient production

– Demand (marginal benefit) intersects

marginal social cost curve

– Government regulation

• Limit production

• Tax = marginal external cost

– Marginal social cost = marginal benefit

– Total social gain

• Total social cost (firms ignore external cost)

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Exhibit 1

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Negative Externalities: The Market for Electricity in the Midwest

0.10

$0.14

Dolla

rs p

er

kilo

watt

-hour

Marginal

social cost

350

Millions of kilowatt-hours of electricity per month

50

Marginal

private cost

D

a

c

If producers base their output on

marginal private cost, 50 million

kilowatt-hours of electricity are

produced per month. The

marginal external cost of

electricity is the cost of pollution

imposed on society. The

marginal social cost curve

includes both the marginal

private cost and the marginal

external cost. If producers base

their output decisions on

marginal social cost, only 35

million kilowatt-hours are

produced, which is the optimal

output. The total social gain

from basing production on

marginal social cost is reflected

by the blue-shaded triangle.

Total social gain

b






• External costs with variable technology

– Variable technology

• Reduce emissions: alter the production

process

• Cleaner technology

– Production of cleaner air

• Diminishing returns

9






• Reducing greenhouse gases

– Marginal social cost curve

• Upward-sloping

– Marginal social benefit curve

• Downward-sloping

• Diminishing marginal benefit to society

– Optimal level of air quality

• Marginal social benefit = marginal social cost

– Higher than optimal level of air quality

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Exhibit 2

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The Optimal Reduction in Greenhouse Gas EmissionsD

olla

rs p

er

unit

Total

social

gain

Marginal

social cost

Marginal

social benefit

AHigh

Greenhouse gas emissions

A’ Low

a

b

c

The optimal level of greenhouse

gas emissions is found at point a,

where the marginal social benefit

of reducing such emissions

equals the marginal social cost. If

some lower level of emissions

were dictated by the government,

such as A’, the marginal social

cost would exceed the marginal

social benefit, and social waste

would result. The total social

waste resulting from a lower than

optimal level of emissions is

shown by the pink-shaded

triangle.






• Shift in marginal social cost curve

– Technological breakthrough

• Lower marginal cost of cutting greenhouse

gas

– Downward shift of MSC curve

– Lower optimal level of emissions

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• Shift in marginal social benefit curve

– Higher marginal benefit of reducing

emissions

• Upward shift of MSB curve

• Lower optimal level of emissions

13



Exhibit 3

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Effect of Changes in Costs or Benefits of Reducing

Greenhouse Gas Emissions

Marginal

social benefitMarginal

social cost

Dolla

rs p

er

unit

A0 A’ Higher

quality air

Marginal

social

benefit

Marginal

social cost

Dolla

rs p

er

unit

A0 A’’ Higher

quality air

MSC’

(a) Lower cost of reducing emissions (b) Greater benefit of reducing emissions

MSB’

Either a reduction in the marginal social cost of cleaner air, as shown in panel (a), or

an increase in the marginal social benefit of cleaner air, as shown in panel (b),

increases the optimal level of air quality.






• The Coase theorem

– For low transaction costs

– Efficient solution

• Least cost solution

• Assign property right to one party

• One side bears the externality cost

– Inefficient outcome

• If high transaction cost

• If large number of parties involved

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• Market for pollution rights

– Government

• Sells pollution rights

• Limits maximum level of pollution per day

– Firms

• D = marginal value of pollution

• Buy pollution rights

– Value of pollution permits

• Fluctuates

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Exhibit 4

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Optimal Allocation of Pollution Rights

1000 250

Tons of discharge per day

Dolla

rs

per

ton

25

$35

D’

D

S

Suppose the demand for a river

as a discharge service is D. In

the absence of any

environmental controls, polluters

dump 250 tons per day, where

the marginal benefit of discharge

is zero. If regulatory authorities

establish 100 tons as the

maximum daily level of discharge

and then sell the rights, the

market for these pollution rights

clears at $25 per ton. If the

demand for pollution rights

increases to D’, the market-

clearing price of pollution rights

rises to $35 per ton.





Pollution Rights & Public Choice

• Pollution regulation

– Special interest of polluters

• Before 1990

– Command-and-control environmental

regulations

• Particular technologies to reduce emissions

• Market for pollution rights

– Economic efficiency approach

• Reduce emissions: Cost-effective

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Environmental Protection

• Environmental Protection Agency EPA

• Clean air act of 1970

• Clean water act of 1972

• Resource conservation and recovery act

of 1976

• Superfund law of 1980

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Air Pollution

• Atmosphere

– Economic resource

– People value clean air; willing to pay

more

• Smog

– 40% from automobile emissions

– 40% from consumer products

– 15% from manufacturing

20





Air Pollution

• Clean air act of 1970

– 90% reduction in auto emissions

– By 1990, average emissions fell

• Lead: 97%

• Monoxide: 41%

• Sulfur dioxide: 25%

• U.S. air quality: good

• U.S. – major source of fossil-fuel carbon

dioxide emissions

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Exhibit 5

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Fossil-Fuel Carbon

Dioxide Emissions

per Capita: The 25

Worst Nations





Air Pollution

• We need to cut air pollution by:

– Sharply improving energy efficiency in

buildings, vehicles, and machines

– Shifting from fossil fuels to nuclear, wind,

solar, and other renewable energy

sources

– Preserving forests as absorbers of

carbon dioxide, or as “carbon sinks”

– Capping agricultural emissions

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Water Pollution

• Sources

– Sewage

– Chemicals

– Oil

• Sewage

– Dumped into waterways; no cleaning

• Negative externality

– Federal money: treatment plants

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Water Pollution

• Chemicals

– 10% from point pollution

• Factories, industrial sites

– Two thirds – from nonpoint pollution

• Runoff from agricultural pesticides and

fertilizers

– In most states: pesticides have fouled

some groundwater

25





Water Pollution

• Oil

– Cleanup of oil spills on land – overseen

by the EPA

– 600,000 underground storage tanks for

oil and chemicals

• Potential threat of contamination for

groundwater

– Cleanup of offshore oil spills - overseen

by the U.S. Coast Guard

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Hazardous Waste

• Before 1980

– Firms - Pay others to haul and dispose

• Not responsible for cleaning

• Superfund law of 1980

– Comprehensive Environmental Response,

Compensation, and Liability Act

– Companies - Pay others to haul and

dispose

• Pay for clean up

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Solid Waste:”Paper or Plastic?”

• U.S. households

– 4 pounds of garbage per resident per day

• Mostly packaging

– 200 million tons per year

• 70% of garbage - landfills

• Recycled: 15% of garbage

– 75% paper products

• 15% - incinerated

– Trash-to-energy plants28



Exhibit 6

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Paper Recycling Rates of Top Ten Paper-Producing Countries





Solid Waste:”Paper or Plastic?”

• 2 out of 3 aluminum cans: recycled

• Returnable deposit laws

– Increase recycling

• Recycling: imposes environmental costs

– Curbside recycling

• Trucks

– Newsprint

• De-inked

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Positive Externalities

• Beneficial externalities

– Consumption or production benefits other

consumers or other firms

• Vaccination

– Personal benefits

– Benefits to society

• Positive externality

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• Public policy

– To increase quantity beyond private

optimum

• Marginal social benefit

– Includes all the benefits for society

• Private benefits

• External benefits

• Marginal social benefit curve

– Above the private demand curve

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Exhibit 7

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Education and Positive Externalities

E0 E’

Quantity of education per period

Dolla

rs p

er

unit

DMarginal

private benefit

D’

Marginal

social benefit

SMarginal

cost

e’

e

In the absence of government

intervention, the equilibrium

quantity of education is E, where

the marginal private benefit of

education equals the marginal

cost as reflected by the supply

curve. Education also confers a

positive externality on the rest of

society, so the social benefit

exceeds the private benefit. At

quantity E, the marginal social

benefit exceeds the marginal

cost, so more education

increases social welfare. In this

situation, government tries to

increase education to E’, where

the marginal social benefit equals

the marginal cost.






• Positive externalities

– Decisions based on private marginal

benefits

• Result in less than the socially optimal

quantity of the good

– Point to market failure

– Public policy: increase quantity beyond

the private optimum

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Ch 17 externalities and the environment micro econ4

Economy & Finance

Transcript of Ch 17 externalities and the environment micro econ4