Econ Chapter 17.1-17.2

3 types of policies designed to bring about optimal amount of pollution abatement:

1. Direct Controls (Command-and-Control policies) 2. Emissions taxes 3. Tradable Pollution Permits

"Cap and Trade" system's two parts:

1. The government mandates a limit (or "cap") on the total amount of pollution of some specific type. 2. The government distributes permits to firms (either by granting or auctioning) allowing the firms to emit a specified amount of pollution.

Pollution-control authority faces 3 problems:

1. The private sector will not, by itself, create a market in pollution control. Hence, the government must intervene in private-sector markets if the optimal level of control is to be attained. 2. The optimal level of pollution abatement is not easily known because the marginal benefit and the marginal cost curves are not usually observable. The government can only estimate these curves, and accurate estimates are often difficult to obtain. 3. The available techniques for regulating pollution are themselves imperfect. Even if the optimal level of pollution abatement were known with precision, there are both technical and legal impediments to achieving that level through regulation.

Internalizing the Externality

A process that results in a producer or consumer taking account of a previously external effect.

When there are negative externalities, social marginal cost

EXCEEDS private marginal cost because the act of production generates costs for society that are not faced by the producer.

Tradable pollution permits

Rights to emit specific amounts of specified pollutants that private firms may buy and sell among themselves. The total quantity of permits is set by government policy.

Improvements in abatement technology will lead to

a reduction in the demand for emissions permits and thus a reduction in their equilibrium price. The total cost of a given amount of pollution abatement will be minimized.

Monitoring and enforcement of direct pollution controls are

costly, and this costliness reduces the effectiveness of the controls.

Emissions taxes can lead to

efficient pollution abatement.

When the government does not know firms' abatement technologies, a cap-and-trade system

ensures a certain quantity of pollution abatement but imposes an uncertain cost on polluting firms.

Zero environmental damage is

generally not allocatively efficient.

The equilibrium price in the market for pollution permits is determined by

government policy and by firms' technology of pollution abatement.

When the government does not know firms' abatement technologies, emissions taxes

impose a certain per unit cost on polluting firms but result in an uncertain amount of pollution abatement.

Internalizing the Externality causes firms to

produce a lower level of output.

The socially optimal is such that the social marginal cost equals the

social marginal benefit.

If emissions taxes are set equal to the marginal external cost of the pollution,

the externality will be fully internalized and the allocatively efficient amount of pollution abatement (and output) will be produced.

The optimal amount of pollution abatement occurs where the marginal cost of reducing pollution is just equal to

the marginal benefits from doing so. (Where supply and demand intersect)

Direct controls aimed at reducing pollution are not productively efficient because

the marginal cost of abatement is not equalized across all firms.

Pollution is being abated efficiently when

the marginal cost of pollution abatement is the same for all firms.

With tradable pollution permits, profit-maximizing firms will reduce pollution until

their marginal abatement costs equal the price of pollution permits. The costs of a given amount of pollution abatement will be minimized.

Direct pollution controls are usually inefficient because

they do not minimize the total cost of a given amount of pollution abatement.

A disadvantage with emissions taxes is that info necessary to determine the optimal tax rate is often

unavailable.