Economic Solutions to Environmental Problems: The Market Approach Chapter 5 © 2004 Thomson Learning/South-Western.

Economic Solutions to Environmental Problems: The

Market Approach

Chapter 5

© 2004 Thomson Learning/South-Western

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Descriptive Overview

Market approach – an 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

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Descriptive Overview

Identifying Types of Market Instruments Pollution charge Subsidies Deposit/refund systems Pollution permit trading systems

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Pollution Charges

Pollution charge – a fee that varies with the amount of pollutants released

“Polluter-pays principle” Product charge – a fee added to the price of a

pollution-generating product based on its quantity or some attribute responsible for pollution

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Pollution Charges

Modeling a Product Charge as a Per Unit Tax Policy motivation of a product charge is to induce

firms to internalize the externality by taking account of the MEC in their production decisions

Pigouvian tax – a unit charge on a good whose production generates a negative externality such that the charge equals the MEC at QE

Assessing the Model Difficult to identify the dollar value of MEC at QE

Model implicitly allows only for an output reduction to abate pollution

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Pollution Charges

Figure 5.1 Implementation of a Pigouvian Tax to Achieve Efficiency

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Pollution Charges

Modeling an Emission Charge: Single-Polluter Case

Emission or effluent charge – a fee imposed directly on the actual discharge of pollution

Assessing the Model Emission charge stimulates the natural economic

incentives of the polluter

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Pollution Charges

Figure 5.2 Modeling an Emission Charge for a Single Firm

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Pollution Charges

Figure 5.3 Effect of Technology Improvement on a Firm’s Least-Cost Decision Making

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Pollution Charges

Modeling an Emission Charge: Multi-Polluter Case Assessing the Model

Emission charge exploits each polluter’s natural incentive to pursue a least-cost strategy

Low-cost abaters do most of the cleaning up and high-cost abaters pay more in taxes to cover the greater damages they cost

Potential increase in monitoring costs Part of tax burden is shared with consumers in form of

higher prices

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Pollution Charges

Figure 5.4 Effect of an Emission Charge in a Two-Polluter Model

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Pollution Charges

Pollution Charges In Practice Internationally, pollution charge is most commonly used

market-based instrument Several countries use effluent charges to control the

noise pollution generated by aircraft Real-world application of the product charge is one

levied on lubricant oils by Finland, Hungary, and Italy

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Environmental Subsidies

Two major types of subsidies: Abatement equipment subsidies Pollution reduction subsidies

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Environmental Subsidies

Modeling an Abatement Equipment Subsidy Abatement equipment subsidy – a payment aimed at

lowering the cost of abatement technology Attempts to internalize the positive externality

associated with the consumption of abatement activities

Pigouvian subsidy – a per unit payment on a good whose consumption generates a positive externality such that the payment equals the MEB at QE

Assessing the model Difficulty measuring the MEB May bias polluters’ decisions about how best to abate

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Environmental Subsidies

Modeling a Per Unit Subsidy on Pollution Reduction

Per unit subsidy on pollution reduction – a payment for every unit of pollution removed below some pre-determined level

Assessing the Model Might be less disruptive than an equipment subsidy Can have perverse effect of elevating pollution levels

in the aggregate

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Environmental Subsidies

Environmental Subsidies in Practice Internationally, many countries offer environmental

subsidies in the form of grants or low-interest loans In the United States, the most common use is federal

funding for publicly owned treatment works

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Deposit/Refund Systems

Deposit/refund system – 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

Combines the incentive characteristic of a pollution charge with a built-in mechanism for controlling monitoring costs

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Deposit/Refund Systems

Economics of Deposit/refund Systems Intended to force the potential polluter to account for

both the marginal private cost (MPC) and the marginal external cost (MEC) of improper waste disposal

Targets the potential polluter instead of penalizing the actual polluter

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Deposit/Refund Systems

Modeling a Deposit/Refund System Deposit serves the same function as a pollution

charge with the critical difference that the refund helps to deter improper waste disposal

Assessing the Model Encourages environmentally responsible behavior

without adding to monitoring and compliance costs Can be used to encourage more efficient use of raw

materials

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Deposit/Refund Systems

Figure 5.5 A Pigouvian Subsidy in the Market for Scrubbers

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Deposit/Refund Systems

Deposit/Refund Systems in Practice Beverage container disposal Disposal of used tire, car hulks, and lead-acid

batteries

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Deposit/Refund Systems

Figure 5.6 Modeling a Deposit/Refund System in the Market for Waste Disposal

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Pollution Permit Trading Systems

Pollution permit trading system – a market instrument that establishes a market for rights to pollute by issuing tradeable pollution credits or allowances

Pollution credits – tradeable permits issued for emitting below an established standard

Pollution allowances – tradeable permits that indicate the maximum level of pollution that may be released

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Pollution Permit Trading Systems

Structure of a Pollution Trading Systems Two components:

The issuance of some fixed number of permits in a region

A provision for trading these permits among polluting sources within that region

Bargaining gives rise to a market for pollution rights

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Pollution Permit Trading Systems

Modeling a Pollution Permit System for Multiple Polluters

Incentive to trade as long as two firms face different MAC levels

Trading will continue until the incentive to do so no longer exists, at which point, the cost-effective solution is obtained

Assessing the Model Trading establishes the price of a right to pollute

without intervention No tax revenues are generated Trading system is more flexible

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Pollution Permit Trading Systems

Pollution Trading Systems in Practice Still in early stages of development Few international examples In the United States, Clean Air Act Amendments

of 1990 establish an allowance-based trading program to control sulfur dioxide emissions