sa-02x07

1. This course is prepared under the Erasmus+ KA-210-YOU Project titled
«Skilling Youth for the Next Generation Air Transport Management»
Sustainability
Management in Aviation
The economic perspective – ‘Externalities’ and
environmental policy – Part VII
Prof. Dr. Frank Fichert
Worms University of Applied Sciences

2. The economic perspective – Part VII 2
Environmental policy - overview
There are different types of instruments that policy makers can use for
reducing emissions and damage (also as combinations):
• Information and ‘moral suasion’
• ‘Command and control’ policy / ‘Technical’ regulation
Many examples: limits to emissions, standards for products or processes
• (Financial) incentives, esp. taxes and subsidies
• Emissions trading schemes and ‘offsetting’
In this section of the course, the instruments will be analyzed in a
general/theoretical way, examples and specific applications will be provided
with respect to the different types of emissions (e.g. ETS for CO2 emissions
in 4th section of the course)

3. The economic perspective – Part VII 3
Environmental policy - criteria
There are several criteria for an assessment of policy instruments:
• Effectiveness
Will emissions/damage be reduced? / Will the environmental objective be reached?
(Depending on the existence of a quantified target.)
• Efficiency
Static: Will emissions be reduced at minimum cost?
Dynamic: Is there an incentive to further reduce the costs of emission abatement?
• Political feasibility
Covers all aspects that might be relevant for practical implementation, e.g. effects on
growth, employment, income distribution, trade, etc., including also legal aspects

4. The economic perspective – Part VII 4
Information and ‘moral suasion’
States might provide ‘neutral’ information on emissions (e.g. an emissions
calculator comparing air and rail travel) – might help travelers that want to
reduce their ‘footprint’ to take the right decision.
States might try to ‘convince’ firms and/or households to behave in an
environmental friendly way (and they might threaten to take other measures
if they do not change their decisions/behavior)
Effectiveness?

5. The economic perspective – Part VII 5
Command and control policy
Many different types of ‘technical’ regulation (and other types of
provisions) exist:
Command and control policy might refer to products (e.g. a ban on short-
haul flights or a mandatory provision of specific information – e.g. labelling)
and/or processes (e.g. flight procedures that limit noise).
Technical standards for processes often refer to emissions, but the
specific design is quite diverse. For example, there might be a limit on
emissions per year, per day or per hour, per unit of fuel burnt or per
kilometer driven/flown.

6. The economic perspective – Part VII 6
Command and control policy
The effectiveness of technical standards depends on the design of the
standard and market developments. For example, technical standards limit
noise emissions of aircraft (details will follow in section 3). However, if the
number of aircraft movement increases, the overall noise level might
increase in spite of these standards.
Many economists criticize technical standards due to their inefficiency.
On the next slide, a simple model will illustrate this point of criticism.

7. The economic perspective – Part VII 7
(In-)Efficiency of standards
Assume two
firms, emitting A0
and B0 in the
starting situation.
Political decision:
both have to
reduce emissions
by 50%.
=> A1 and B1
MAC MAC
emissions emissions
Firm A Firm B
A0 B0
A1
B1

8. The economic perspective – Part VII 8
(In-)Efficiency of standards
A1 and B1 are
effective
(emissions are
reduced by 50%),
but not efficient.
Same total
emissions but
lower total costs if
A would be
allowed to emit
one unit more
and B would emit
one unit less.
Minimum cost if
MAC for last unit
of emissions of
both firms are the
same
(red dashed line)
MAC MAC
emissions emissions
Firm A Firm B
A0 B0
A1
B1

9. The economic perspective – Part VII 9
(In-)Efficiency of standards
Uniform standards are inefficient, if marginal abatement costs differ.
If marginal abatement cost would be identical, uniform standard would be
efficient (at least from static perspective).
In theory, standards might be differentiated based on abatement costs, but
information is not available for government (and firms would have an
incentive to communicate higher abatement costs to government).
Moreover, remaining emissions are ‘free’, therefore no incentive to invest
into new technologies that would go beyond the standard.

10. The economic perspective – Part VII 10
Taxes (and other ‘incentives’)
Textbook example: quantity tax per unit of emissions (other design possible)
Efficient, each polluter will reduce emissions until marginal abatement costs
equal tax rate. Also efficient from a dynamic perspective. Tax has to paid for
remaining emissions, this is an incentive to invest into new technologies.
Problems:
• If marginal abatement costs are not known to government, a trial-and-
error process might occur.
• From the perspective of the polluter, costs are higher than in case of a
technical standard (remaining emissions are not free), causing higher
political ‘resistance’.

11. The economic perspective – Part VII 11
Emissions tax
If tax rate t per
unit of emissions,
A will choose A1,
B will choose B1.
Tax revenue:
t*A1 + t*B1
MAC MAC
emissions emissions
Firm A Firm B
A0 B0
A1
B1
t

12. The economic perspective – Part VII 12
Emissions tax
Firms have
incentive to invest
in new
technologies (and
research):
MAC function will
be shifted toward
origin (all else
equal).
Emissions
decrease from A1
to A2.
MAC
emissions
Firm A
A0
A1
t
A2

13. The economic perspective – Part VII 13
Emissions trading scheme
State/government determines maximum level of emissions.
Firms have to have permission (allowance, permit) to emit (issued per unit
of emission)
Those ‘allowances’ are ‘tradeable’. Firms can decide whether to reduce
emissions and sell (not buy) allowance or to use/buy allowance and emit.

14. The economic perspective – Part VII 14
Emissions trading scheme
Each firm will
reduce emissions
until MAC equal
price of permit.
Instrument is
effective as well
as efficient.
Likewise to a tax,
firms have an
incentive to invest
into R&D
MAC
emissions
A0
p
Q

15. The economic perspective – Part VII 15
Emissions trading scheme
Different options for initial allocation of permits:
• Free allocation (different options with specific pros and cons,
e.g. ‘grandfathering’ based on past emissions or based on output)
• Auction (effects very similar to tax, but with uncertainty about price of
permit)
Allocation will (only) determine ‘winners’ and ‘losers’ of the scheme,
therefore always controversial.

16. Next sets of slides will deal with different environmental problems
and the specific use of instruments for emissions reduction.
The economic perspective – Part VII 16
Environmental policy
=> Please continue with video/slides ‘Sust S/V 03-01’