Chapter 5 - Economic Solutions To Environmental Problems (The Market Approach):
In this case, the government agrees to pay the polluter a subsidy (s) for every unit of pollution below some standard (Zst). Total Subsidy = (Zst - Z0) Z0 = Actual level of pollution Suppose that the Zst is set at 200 tons of emissions per month, and the subsidy (s) is set at $100 per ton per month. Them, if a polluter reduces its emissions to 180 tons per month, it would receive a subsidy of?
$100 (200) - 180 = $2000
What are some drawbacks of equipment subsidies?
- It biases polluters' decisions about how best to abate. - Subsidies affect relative prices, making other alternatives less attractive from a financial perspective. - However, some of these abatement alternatives might be more effective in reducing pollution. - Subsidies must be financed through taxes or government borrowing. Thus, they effectively redistribute income from society to polluters, an outcome some view as unacceptable despite the associated gain of a cleaner environment.
What are objectives to the trading system?
- It can create hot spots (localized areas facing high concentrations of pollutants where most of the permit buying takes place). Another objection is the potential for elevated administrative costs to keep records of trades and emissions of buyers and sellers.
What are the caveats of the emissions charge?
- The government will not know the tax rate at which polluters' abatement levels collectively meet the standard and therefore will have to adjust the tax until the environmental objective is achieved. This adjustment process can be time intensive. - Monitoring is likely to be more complex and costly when each polluter responds to a policy based on their own internal operations. - Because polluting firms pay higher taxes, part of the tax burden is shared with consumers in the form of higher prices. - Job losses also may occur as firms adjust to the tax or change technologies to increase abatement. - Firms can try to evade the tax by illegally disposing of pollutants. To minimize that potential, the government may have to strengthen its monitoring programs which adds to costs.
What are the two major types of subsidies?
1. Abatement Equipment Subsidies 2. Pollution Reduction Subsidies
What are the policy instruments that use market incentives?
1. Pollution Charges 2. Subsidies 3. Deposit/Refund Systems 4. Pollution Permit Trading Systems
A system of marketable pollution permits has two key components:
1. The issuance of some fixed number of permits in a region 2. A provision for trading these permits among polluting sources within that region
In theory, the Pigouvian tax forces firms to lower production to the efficient level. Although theoretically pleasing, this instrument is difficult to impose in practice and is not commonly used. Why?
1. There is difficulty in identifying the dollar value of MEC at Qe and htence the level of the tax. 2. The model implicitly allows only for an output reduction to abate pollution - an unrealistic restriction.
These are implemented through grants, low-interest loans, or investment tax credits, all of which give polluters an economic incentive to invest in abatement technology.
Abatement Equipment Subsidies.
These subsidies are aimed at reducing the costs of abatement technology.
Abatement Equipment Subsidies.
The trading component of the permit system capitalizes on differences in polluters' abatement technologies and opportunities. Sources that can abate efficiently are given the incentive to do so because they can sell their unused permits to their less efficient counterparts. As long as the environmental goal is achieved in the _____, the benefit to society is the same whether the task is undertaken by a select few or by all the firms doing the abating. The costs, however, will be lower if abatement is done by more efficient producers.
Aggregate.
Market instruments are aimed at bringing the external costs of environmental damage...
Back into the decision-making of firms and consumers.
However, compared to the other incentives, it is also possible for the government to use the price-quantity relationship in the opposite direction...
By establishing the quantity of pollution or abatement to be achieved and letting the market determine the price. WITH PERFECT INFORMATION, either approach is viable and will lead to the same outcome.
If the permits were allocated equally across all polluters and no trading were allowed, the result would be no different than a _____.
Command-and-control system of uniform standards.
The market approach can be a _____ solution to environmental problems.
Cost-Effective.
It can be used to encourage more efficient use of raw materials. An inordinate amount of used products and materials ends up in landfills or burned in incinerators, when they could be recycled. The availability of recycled products and wastes can help slow the depletion of such virgin raw materials as aluminum and timber and may result in associated price declines as well.
Deposit/Refund System.
It combines the incentive element of a pollution charge with a build-in mechanism for controlling monitoring costs. It wants to prevent improper waste disposal with common targets being beverage containers and lead-acid batteries.
Deposit/Refund System.
Operationally, the _____ attaches a front-end charge (the deposit) for the POTENTIAL occurrence of a damaging activity and guarantees a return of that charge (the refund) upon assurance that the activity has not been undertaken.
Deposit/Refund System.
Taken together, this targets the potential polluter instead of penalizing the actual polluter, using the refund to reward appropriate behavior.
Deposit/Refund System.
The value added of the _____ is that the refund encourages environmentally responsible behavior without adding significantly to the government's monitoring and compliance costs.
Deposit/Refund System.
This is a market instrument that imposes an upfront charge to pay for potential damages and refunds it for returning a product for proper disposal or recycling.
Deposit/Refund System.
What makes this instrument unique is that once established, the incentives operate with limited supervision.
Deposit/Refund System.
_____ are designed to force the potential polluter to account for both the marginal private cost (MPC) and the marginal external cost (MEC) of improper waste disposal should that activity be undertaken. As with the pollution charge, the deposit is intended to capture the MEC of improper waste disposal. The deposit forces the polluter to internalize the damage it may cause by making it absorb this cost in advance.
Deposit/Refund System.
This is a market-based instrument. This is a system that imposes an up-front charge to pay for potential pollution damages that is returned for positive action, such as returning a product for proper disposal or recycling.
Deposit/Refund.
Charging firms a deposit on raw materials acts as a tax, encouraging more efficient use of resources _____ the production process.
During.
_____ incentives encourage the firm to advance its abatement technology. More efficient abatement techniques would allow the firm to reduce pollution more cheaply and enjoy cost savings. The lower abatement costs might even allow the firm to avoid paying any emission charges. This would cause a downward shift in MAC.
Dynamic.
It assigns a price to pollution - typically through a tax. The pollution charge forces the polluter to confront those damages, pay for them, and in so doing, consider them as part of its production costs. Faced with this added cost, the polluting firm can either continue polluting at the same level and pay the charge OR invest in abatement technology to reduce its pollutant releases and lower its tax burden. The firm will choose an action to minimize its costs.
Emission/Effluent Charge.
It is a fee imposed directly on the actual discharge of pollution.
Emission/Effluent Charge.
Perhaps the best known applications of deposit/refund systems are those used to...
Encourage proper disposal of beverage containers. Other initiatives are aimed at encouraging responsible disposal of such products as used tires, car hulks, and lead-acid batteries. Proper discard of lead-acid batteries is of particular concern because of the health risks linked to lead exposure.
The _____ encourages proper disposal or recycling of raw material waste as the _____ of the production phase. Firms that elect to ignore this incentive face not only conventional disposal costs but also the opportunity cost of the forgone refund.
End.
You can also pay polluters to NOT pollute through an _____.
Environmental Subsidy.
_____ are implemented in a variety of ways such as through grants, rebates, tax exemptions, and tax credits.
Federal Subsidies.
In the U.S., the most common use of subsidies is...
Federal funding for such projects as publicly owned treatment works. Federal subsidies are also used to promote the use of pollution control equipment and encourage the use and development of cleaner fuels and low-emitting vehicles.
A common application of environmental subsidies is in the form of...
Grants and low-interest loans.
What is a drawback of a per-unit pollution reduction subsidy.
However, these subsidies can have a perverse effect of elevating pollution levels in the aggregate. The per-unit subsidy effectively lowers a polluter's unit costs which raises profits. If the industry has limited entry barriers, these profits would signal entrepreneurs to enter the industry. IN THE LONG-RUN, although each individual polluter reduces its emissions, the subsidy may cause the market to expand such that aggregate emissions end up higher than they were originally. This dilemma could be solved if entry were prohibited or at least limited in some way.
What are the caveats of using a Pigouvian subsidy?
It is difficult to measure the MEB. Monetizing the marginal external benefits of such intangibles as better health and more stable ecosystems is very difficult. So, it is not likely that a subsidy of abatement equipment will achieve allocative efficiency. - However, its associated effect of encouraging greater consumption because of an effectively lower price should still occur.
Why might a per-unit pollution reduction subsidy be less disruptive than an equipment subsidy?
It is established independent of the abatement method uses and thus avoids any technological bias.
What is the primary distinction between the market approach and the command-and-control approach?
It is the WAY in which environmental objectives are implemented versus the level at which those objectives are set. It is different in how it attempts to achieve those objectives (AKA the design of policy instruments).
If a subsidy were offered for installing specific abatement equipment, such as scrubbers, quantity demanded would increase because the effective price would be lower. To achieve an efficient equilibrium, the subsidy would have to equal the marginal external benefit of scrubber consumption measured at the efficient output level.
Key Concept.
Pollution Permit Trading System. The fixed number of permits issued is bound by whatever pollution level is mandated by _____, capping emissions to meet that regulated level. For example, if the level were set at 200 units of emissions, a maximum of 200 one-unit permits could be issued.
Law.
Because there is an incentive for trade as long as the two firms face different _____ levels, Round 2 (see notes) does not represent a cost-effective solution.
MAC.
The ____ is the demand for improper waste disposal.
MPBiw. It is motivated by the avoidance of time and resources to collect wastes, bring non-recyclables to a landfill, and haul recyclables to a collection center.
The _____ includes expenses for collecting and illegally dumping wastes plus the costs of improperly disposing recycling wastes, such as the expense of trash receptacles, collection fees paid to refuse companies, and the opportunity costs of forgone revenue associated with recycling.
MPCiw.
Distinct from the use of more traditional command-and-control instruments, the _____ uses price or other economic variables to provide incentives for polluters to reduce harmful emissions.
Market Approach.
It allows polluters to respond according to their own self-interests.
Market Approach.
It attempts to restore economic incentives by assigning a value to environmental quality/pricing pollution. Once done, firms and consumers adjust their behavior to the resulting change in market conditions.
Market Approach.
Improper or illegal waste disposal gives rise to _____.
Negative Externalities. The external costs include health damages, such as lead contamination from discarded lead-acid batteries, and aesthetic impairment from litter and trash accumulation.
This is a payment for every unit of pollution removed below some predetermined level.
Per-Unit Subsidy On Pollution Reduction.
This is a subsidy based on emission or effluent reductions.
Per-Unit Subsidy On Pollution Reduction.
For example, in the United States, air pollution policies are designed to achieve national ambient air quality standards within well-defined regions. Within any region, however, some polluters might perform above the standard and others below it, which is acceptable as long as in the aggregate the region is in compliance. This is exactly how the _____ operates—controlling the total amount of emissions in a region but not the releases for each source within that region.
Permit Systems.
Of all the available control instruments, _____ are the most market-oriented.
Permit Trading Systems. Example: Much of the initial development of these programs has occurred in the United States at the federal level. In attempting to combat the adverse effects of acid rain, the Clean Air Act Amendments of 1990 established an allowance-based trading program to control sulfur dioxide (SO2) emissions. For example, in an effort to reduce urban smog, a group of northeast-ern states organized the Ozone Transport Commission, which ultimately designed and implemented a tradeable permit system to reduce nitrogen oxide (NOx) emissions. On a global scale, a trading program that has received considerable worldwide attention is the tradeable permit system for greenhouse gases (GHGs) established by the Kyoto Protocol, an international accord that addresses global warming.
This is a unit charge on a good whose production generates a negative externality such that the charge equals the MEC at Qe.
Pigouvian Tax.
It is a position rooted in the belief that the polluter should bear the costs of control measures to maintain an acceptable level of environmental quality.
Polluter-Pays Principle.
Thus far, we have illustrated that market instruments can be used to set prices for...
Polluting and abatement activities.
If the system uses _____, each permit gives the bearer the right to release some amount of pollution.
Pollution Allowances.
What is the classical solution to negative externalities?
Pollution Charge (Product Charge Implemented As A Tax)
A _____ is a fee that varies with the quantity of pollutants released.
Pollution Charge.
It can be implemented as a product charge or as an effluent or emission charge.
Pollution Charge.
It is the idea of internalizing the cost of environmental damages by pricing the pollution-generating activity.
Pollution Charge.
This is a market-based instrument. It is a fee charged to the polluter that varies with the number of pollutants released.
Pollution Charge.
Internationally, what is the most common market-based instrument?
Pollution Charge. - Japan, for instance, uses fees or taxes to control the noise pollution generated by an aircraft. - Canada, for instance, uses effluent charges to protect water resources. - A real-world application of a product charge is one levied on batteries. - There is also a product charge on automobile tires. Finland uses this product charge to help cover the costs of collecting and recycling used tires.
Permit Systems: The final abatement location for these firms is identical to what happens if a _____ is used.
Pollution Charge. This is because both instruments are incentives linked to the firm's MAC.
Under a system of ______, a polluter earns marketable credits only if it emits below an established standard.
Pollution Credits.
Polluters can buy and sell allowances as needed based on their access to abatement technologies and their costs.
Pollution Permit Trading System.
This is a market instrument that establishes a market for rights to pollute by issuing tradeable pollution credits or allowances.
Pollution Permit Trading System.
This is a market-based instrument. This is the establishment of a market for rights to pollute using either credits or allowances.
Pollution Permit Trading System.
This policy instrument operates from a known variable (the socially desirable quantity of pollution OR abatement) and lets the market establish the price.
Pollution Permit Trading System.
Impose a unit tax on the pollution-generating product equal to the MEC at the efficient output level (Qe).
Product Charge.
The motivation of a _____ is to induce firms to internalize the externality by taking account of the MEC in their production decisions.
Product Charge.
This is a fee added to the price of a pollution-generating product based on its quantity or some attribute responsible for pollution.
Product Charge.
In the presence of differing MAC levels among polluting sources, high-cost abaters have an incentive to _____ permits from low-cost abaters, and low-cost abaters have an incentive to sell them.
Purchase. Low-cost abaters will do what they do best—clean up the environment—and high-cost abaters will pay for the right to pollute by buying more permits. Trading will continue until the incentive to do so no longer exists, that is, when the MAC levels across both firms are equal. At precisely this point, the cost-effective solution is obtained.
Unique to the deposit/refund system is the _____ component which introduces an incentive to properly dispose of wastes and hence prevent environmental damage from taking place at all.
Refund.
_____ objectives are set at a socially desirable level rather than an efficient level.
Standards-Based.
_____ incentives motivate the firm to choose among the available options, given its existing technology. Seeking to satisfy its own self-interest to maximize profit, the polluter makes a least-cost decision between paying the tax and abating. The result is that the externality is internalized, using the least amount of resources.
Static.
Because _____ are negative taxes, they have a similar incentive mechanism to pollution charges except that they reward for not polluting as opposed to penalizing for engaging in polluting activities.
Subsidies.
This is a market-based instrument. This is a payment or tax concession that provides financial assistance for pollution reductions or plans to abate in the future.
Subsidy.
At the state level, a common application of environmental subsidies is in the form of...
Tax incentives to encourage recycling activities.
With a deposit/refund system, the horizontal axis measures...
The improper waste disposal (IW) as a percentage of all waste disposal activity. The percentage of proper waste disposal (PW) is measured right to left. Thus, if 25% of all wastes is improperly disposed of, then by default, 75% is disposed of appropriately and safely.
Now, we are assuming that the the pollution charge can also be implemented as an emissions charge which is a tax levied on pollution, instead of a product charge. By moving out of the product market...
The polluter's response is not restricted to an output reduction.
Once the limited permits are distributed, polluters may _____ them with one another. Following their one self-interest, polluters wither purchase these rights to pollute or they abate, whichever is the ______. High-cost abaters have an incentive to _____ and low-cost abaters have an incentive to _____. What is the result?
Trade. Cheaper Alternative. Bid for avaliable permits. Abate and sell their permits on the open market. The result is a cost-effective abatement allocation.
T-F: Any attempt to correct a market problem by imposing third-party controls is likely to have its share of pitfalls.
True.
T-F: From a theoretical perspective, subsidies are used to internalize the positive externality associated with the consumption of abatement activities.
True.
T-F: In one form or another, market-based instruments effectively assign a price to environmental goods, such as clean air and clean water. Once this signaling mechanism is in place, polluters are forced to internalize the costs of pollution damage and adjust their decisions accordingly.
True.
T-F: The market fails to correct environmental problems on its own, but the incentives that define the market process can nonetheless be put to work by policymakers.
True.
T-F: The emission charge exploits each polluter's natural incentive to pursue a least-cost strategy.
True. The low-cost abaters do most of the cleaning up, and the high-cost abaters pay more in taxes to cover the greater damages they cause. Costs are minimized because Polluter 2 does most of the abating. it does so, not because it is motivated by society's objectives, but because doing so is in its own best interest. An added advantage is that the tax generates revenues for the government which can be used to help finance the costs of enforcement and monitoring.
One of the drawbacks of pollution charges is that they may encourage the illegal disposal of contaminants...this is an important motivation for...
Using a deposit/refund system.
What is the difference between the pollution charge and the permit system?
With the pollution charge, the government has to search for the price that will bring about the requisite amount of abatement. In the permit system, trading establishes the price of a right to pollute without outside intervention. The trading system is more flexible. The number of permits can be adjusted to change the environmental objective. If the objective is too stringent, more permits can be introduced. If it is too lenient, the government, environmental groups, or concerned citizens can buy permits, effectively reducing the amount of pollution allowed in the affected region. The pollution charge generates tax revenues on all units of pollution not abated, whereas no revenues are generated from the permit system.