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Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
Economics of Environmental Regulation
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Economics of Environmental Regulation

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These slides cover the basic of environmental regulation including taxes, tradable permits, and command and control.

These slides cover the basic of environmental regulation including taxes, tradable permits, and command and control.

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  • Notice that efficiency does not necessarily require everyone is better off.
    Cost effectiveness is required for efficiency, but not the other way.
    Equity can have many dimensions and criteria by itself.
  • The premise is simple: directly limit the environmentally damaging activity or substance.
    Draw the efficient level of emissions graph, and show that a standard could be limiting the emissions to Q*
    The ambient
  • In fact, it might ignore abatement costs altogether. It could be established according to the risk of damages occurring.
    The problem with uniform standards – show graphically with different MD curves. Implementing different standards is costly in terms of information.
    Show two MAC curves with an equal reduction in emissions.
  • Transcript

    1. Environmental Regulation Environmental Economics Fall 2013
    2. Four General Areas of Regulation to Protect Environmental Quality Regulations (Command and Control) (ex. standards, bans, quotas, takeback laws) Fixing distortions in economic incentives (using markets) – – – – Direct subsidies or subsidy reductions Environmental taxes and user fees Deposit refund systems Tradable permits Creation of markets – Tradable permits, carbon markets – Establishing and enforcing property rights – Public ownership Engaging the Public – Eco-labeling – Education Programs
    3. Criteria for Evaluation • Efficiency – Maximum net benefits to society • Cost-effectiveness – Bang for the buck • Equity – Over time, space, income • Incentives for innovation • Enforceability • Moral grounds
    4. Command-and-Control Policies Standard: a mandated level of performance enforced in law. • Ambient Standards – Water ambient standards – Air quality ambient standards • Emission Standards – Vehicles • Technology Standards – BACT
    5. Setting the Standard • A standard is not necessarily set according to efficiency and/or cost effectiveness considerations. • Many times standards are uniform, e.g. the same nationally. – This may not be efficient if the damages are different in different regions. – Not cost effective if the abatement costs are different for different firms/regions. The equimarginal principle will typically be violated.
    6. Potential Advantages to Regulatory Approaches (standards, bans, quotas, “command and control”) • More traditional so parties may feel more comfortable • Lower administrative costs, responsibilities, and easier enforcement • Effects are more certain (e.g. amount of pollution reduced) • Perceived as having less impact on inflation • Emission standards provide an incentive to innovate (technology standards not so)
    7. Emission Taxes or Charges Firms are charged for the emission they make on a per ton or some other basis. Advantages: – Cost-effectiveness/ flexibility: Allows firms to chose their level of abatement: • Firms with high abatement cost might chose to pay the taxes while firms with low abatement costs would rather abate. – Tax structures already in place – Stimulates development of new technologies continuously (dynamically efficient). – Uses “free-market”. – Raises revenue – ‘double dividend’. – Can send correct price signal through entire economy.
    8. Emission Taxes or Charges Disadvantages: • Difficult to assess correct level. – Based on damage costs? – Based on marginal abatement costs and desired level of abatement? • Unknown emission outcome. • Need to use right tax. • Unpopular.
    9. How to Set the Right Tax level? • Base it on the cost of damages associated with an activity/pollutant/etc. “Pigouvian Tax” – internalizing the external costs. This is not always easy to assess. Various impacts need to be considered: – – – – – – Loss of life Loss of work days Discomfort Damage to material goods (i.e. acid rain) Impact on natural world Aesthetic impact • Base it on the cost of remediation/ amelioration • Base it on mandated emission reductions
    10. Problems with basing tax on damage: • Doesn't work well with persistent pollutants like PCBs which stay in environment. How do you include future values? • Uncertainty – how to value uncertain outcomes? ex. climate change. • Doesn't include interaction between pollutants. • Different areas might require different costs – i.e. urban areas vs. desert • Marginal cost of each ton emitted is not necessarily the same. Maybe cost goes up with higher emission levels.
    11. How to set the socially optimal tax? SMC = social marginal cost PMC = marginal cost MD= marginal damage costs Qe = equilibrium quantity Qs = social equilibrium quantity P SMC PMC MD Demand = social benefit Qs Qe Quantity
    12. How to set the socially optimal tax? SMC = social marginal cost PMC = marginal cost MD= marginal damage costs Qe = equilibrium quantity Qs = social equilibrium quantity P SMC PMC Demand MD Qs Qe Quantity
    13. Value per unit of emissions or abatement Illustration of Optimal Tax Marginal damage cost (MDC) = MB from abatement Marginal abatement cost (MAC) Level w/o abatement Tax Abatement e* e* is the socially optimal level. MAC = least costly way to get a level of abatement e1 Emissions (e.g. SOx)
    14. Value per unit of emissions or abatement Abatement Things are not now optimized; it may be possible to lower emissions and costs. e1 Emissions
    15. 1995 composite figures for cost of damages from criteria air pollutants in California Tax values in $/ton Density NOx High 11,584 Medium 5,216 Low 541 CO 2 0 0 SOx 4,768 1,814 1,814 PM10 37,455 4,578 753
    16. Tradable Permits • Firms are allowed a certain quota of emissions. They can make reductions themselves or trade for reductions at other facilities. • Advantages: – Stimulates new technologies – Promotes efficiency – More certainty about amount of pollution reduction compared to taxes – More politically accepted than taxes • Disadvantage: – – – – Require more administrative capacity/high costs Can be gamed more easily than taxes Can hurt competition Geographical distortions
    17. Permits Can Be Gamed “Traders for big banks and other financial institutions, these people say, amassed millions of the credits just as refiners were looking to buy more of them to meet an expanding federal requirement”. “JPMorgan Chase and other financial institutions …had helped transform an environmental program into a profit machine, contributing to the market frenzy this year”. http://www.nytimes.com/interactive/2013/09/15/business/0915-price-of-an-ethanol-credit.html?ref=business
    18. Tax vs. Permits Unless you know the precise costs of abatement, you don't know how much pollution reduction will occur. Costs Costs Carbon Cap MC MC Tax P? P Q* Abatement Q? Abatement
    19. Tax vs. Permits Ideally, abatement occurs where MB = MC Costs Costs Carbon Cap MC MC Tax P? P MB Q* Abatement MB Q? Abatement
    20. Tax vs. Permits With very steeply changing marginal benefits, cap is better. Costs Costs Carbon Cap EMC P? EMC Tax P MB MB Q* Abatement Q? Abatement
    21. Tax vs. Permits With more horizontal marginal benefits, tax is better. Costs Costs Carbon Cap EMC P? EMC Tax P MB Q* Abatement MB Q? Abatement
    22. Variations in Cost Structures Marginal Damage Costs Marginal Abatement Costs
    23. Mathematical Comparison • Emission limits (regulation) • Tax • Tradable Permit
    24. Mathematical Example of Emission Limits • Three firms all with different MC of pollution reduction. Each firm emits 100 tons of pollution. • The three firms have MC of abatement as follows where Q is quantity of emissions reduced: MCa = 10 + 0.25Qa MCb = 20 + Qb MCc = 10 + 0.5Qc
    25. Each firm needs to reduce by 20% which is 20 tons. MCa = 10 + 0.25Qa MCb = 20 + Qb MCc = 10 + 0.5Qc MC(20) = 10 + 0.25(20) = 15 MC(20) = 20 + 20 = 40 MC(20) = 10 + 0.5(20) = 20 MAC MAC MAC 40 20 20 15 10 10 20% Firm A 20% Firm B 20% Firm C
    26. If they all reduce by 20 tons, total reduction = 60 tons. The resulting total costs (calculated using area method) for each firm are: Firm A: (20 x 10) + (20 x 5)/2 = $250 Firm B: (20 x 20) + (20 x 20)/2 = $600 Firm C: (20 x 10) + (20 x 10)/2 = $300 Total costs = $1150
    27. Emission Taxes or Charges Set tax at $20/ton MAC MAC MAC 20 10 10 40 tons Firm A Zip 20 tons Firm B Firm C
    28. To find out how much each reduces, set MC = to 20 and solve for Q. MCa = 10 + .25Qa = 20 Q = 40 MCb = 20 + Qb = 20 Q=0 MCc = 10 + .5Qc = 20 Q = 20 Again we have a reduction of 60 tons.
    29. What has been the cost of emission reduction? Firm A: (40 x 10) + (40 x 10)/2 = $600 Firm B: 0 Firm C: same as with regulation = $300 Total cost = $900 The cost is lower than with CAC. However, firms still need to pay the taxes on the other emissions.
    30. Total cost of emission tax • • • • Taxes for A = $20 x 60tons = $300 Taxes for B = $20 x 100tons = $2000 Taxes for C = $20 x 80tons = $1600 Total cost to industry = $900 + $3900 in taxes Compared to CAC, cost of reducing same level of emissions is less but total cost to industry is more.
    31. Tradable Permits: 240 permits given away, 80 tons to each firm. • Firm B is going to realize that it costs them more to reduce pollution than firms A and C so it will want to buy permits from these firms. • Firm A can sell up to 20 permits for $20 each to Firm B. • Firm B will pay $20 for permits. • If sale price is $20, total cost of compliance if permits are given away: Firm A: $600 for emission reduction - $400 from Firm B = $200 Firm B = $400 to pay for permits from Firm A Firm C = $300 for emission reduction Total = $900
    32. Firm C does not trade permits. Firm B buys 20 tons of permits from firm A. MAC MAC MAC $20 10 10 40 tons Firm A 20 tons Firm B 20 tons Firm C
    33. The RECLAIM Experience (Fowlie et al. 2011) • NOx and SOx trading program started in 1994. • REgional CLean Air Incentives Market
    34. Industries Are Dynamic • All this well-developed theory associated with the benefit and costs of various government policies for reducing emissions is all based on static analysis. • In reality, the world is far more dynamic. • Well designed regulations can often have private economic benefits to the firms.
    35. Social Value of Regulations • Often not known in advance. • 1990 Clean Air Act Amendments (CAAA): SOx regulation, – Benefits were $3300 per ton, – Costs were $270 per ton (1998 dollars). •
    36. Creating Markets/Enforcing Property Rights • Tradable permits, carbon markets • Establishing and enforcing property rights • Public ownership
    37. The Coase Theorem Economic efficiency will be achieved as long as: – property rights are fully allocated and – completely free trade of all property rights is possible. It does not matter who initially owns the property rights, as long as all rights are defined.
    38. Problems With Coase Theorem • Transaction costs can prevent markets from developing to internalize external costs even with damager liability rules. • Agreements can be difficult to enforce. • Income effects: depending on income of victims, nonmarket damage optima could vary.
    39. In Reality • Well defined property rights unlikely to solve many environmental problems • Government intervention necessary • Intervention more likely with some environmental problems than others
    40. Characteristics of Environmental Problems and Likelihood of Government Control Democratic Control Characteristics Spatial Scale Level of Complexity/ Uncertainty Transparency Less likely >>> More likely >>> Very Likely Global/ foreign High Regional* National Local Very Local Moderate Medium Low Very Low Invisible Somewhat Medium Fairly Visible Obvious Visible Temporal Scale of Distant future Moderate Near Future Very Soon Immediate Impacts Future Sources Very many Many Moderate Few Very Few Source and Target Same Mostly Same Livelihood Impact Human Health Impacts Level of Health Impacts Very Low Indirect Low Somewhat Indirect Light Very Light Similar or Mostly Differ Differ Mixed Medium High Very High Semi-direct Somewhat Direct Direct Medium Heavy Very Heavy * Depends on country size. For large countries, like the United States or China, "national" might be a larger scale than "regional".
    41. Environmental Problem Local - 1 Simple, Transpar- Timing of Sources Source Livelihood Human Level of Global - 5 certain - 1 ancy Effects Few- 1 and Impact Health Health Complex, Obvious-1 Present-1 Many - 5 Target High - 1 Impact Impact uncert. - 5 Invisible- Future - 5 Differ - 1 Low - 5 Direct - 1 Heavy - 1 5 Same - 5 Indirect – Light - 5 5 Total Local water quality 1 1 2 1 4 1 4 1 1 16 Urban air pollution from industry 2 2 1 1 1 1 5 2 2 17 Toxic dumps 1 2 3 1 1 1 5 1 5 20 Indoor air pollution 1 1 2 1 5 5 4 1 1 21 Local deforestation 2 2 1 1 2 4 2 5 5 24 Acid rain 3 2 3 2 2 2 3 4 4 25 Pesticides 2 3 4 2 2 2 4 2 4 25 Urban air pollution from mobile sources 2 2 1 1 5 5 5 2 2 25 Soil erosion 2 4 2 2 3 4 1 4 4 26 Ocean pollution 5 3 3 2 2 1 3 4 4 27 Global deforestation, loss of biodiversity Resource depletion 5 2 3 2 4 2 4 5 5 32 4 3 3 4 4 3 1 5 5 32 Ozone depletion 5 4 4 3 4 3 5 4 2 34 Climate change 5 5 4 5 5 3 5 5 3 40
    42. Other policy options for reducing externalities Engaging the public • Labeling (e.g. timber certification) • Education programs Firm Based • Voluntary over-compliance – Pleasing stake-holders, including employees – Anticipatory compliance – Saving money – Indivisibility of pollution abatement technology • Environmental Accounting
    43. Marginal Costs Might Change Abruptly Example: air pollution emission reduction $ per unit reduction Marginal Abatement Cost Marginal Social Value Emission Reduction
    44. Source: McKinsey and Co. Impact of the financial crisis on carbon economics: Version 2.1 of the global greenhouse gas abatement cost curve http://www.mckinsey.com/client_service/sustainability/latest_thinking/greenhouse_gas_abatement_cost_curves
    45. http://www.mckinsey.com/insights/energy_resources_materials/mobilizing_for_a_resource_revolution
    46. Fin

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