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Environmental and
energy economics
Lecture Moderate
A. Sustainability
1
21.09
What is "sustainability"? Externatilites. Hanley Ch.2, Tietenberg Ch 2
2
29.09
Market failure Tietenberg Ch 2
3
05.10
Global warming Tietenberg Ch 16
4
12.10
First-best optimal instruments
Second-best instruments (subsidies)
Tietenberg Ch 14
Cramton
5
19.10
Optimal extraction of exhaustible sources: the basic model &
extensions
Tietenberg, Ch.5
B. Fossil fuels: Oil, Gas & Coal
6
26.10
Oil. Security of supply. Shale oil, oil shale (kerogen), tar
sands (bitumen). Peak oil, Huber curves and reserves
BP
BP 2013
Edwards p.68-92, 126-157
IER
Smil: Memories of peak oil
Smil 2010: power density primer
7
02.11
Gas. Security of supply: short-term & long-term. The crucial
difference between oil and gas. Bilateral monopoly. "pipe
wars".
Shively-GAS, Chap 1, 2, 10
Ratner
Shively-GAS
Stern
C. Electricity markets
8
09.11
Fundamentals of electricity: The system Shively-E Ch.1, 2, 4, 5, 6, 7.
Biggar Ch. 2
9
16.11
Fundamentals of electricity: Generation Shively-E Ch. 4.
Edwards p.93-112 +117 (California)
10
23.11
Generation: Trading simulation 1a & 1b Edwards p.259-271
Stoft p.33-45, 123-129
11
30.11
Generation: optimal investment, screen curves, load duration
curve, missing money & capacity payments and subsidies
Stoft p.33-45, 123-129
D. Climate policy
12
07.12
Renewable energy sources:
- costs & benefits
- the costs of intermittency
- LCOE and its drawbacks
- the utility dead-spiral
Borenstein 2012
Marcantonini
Taylor
Boehringen
Hirth
Smil 2010
Smil 2014
Reader
13
14.12
E. Enviromental survival: Past and future
- The Green paradox
- Disasters, myths and miracles
Tietenberg, Ch.5
Morris
Wilson
17.12 Exam for exchange students (not for "domestic" ones)
• SUSTAINABILITY
• Hanley, Chap. 2
• What is sustainability?
• What is sustainability?
– Utilitarian approach: look at the discounted
sum of well-being of all people over time.
– Kantian approach: Future generations have
moral rights to a level of well-being no less
than our own.
– Should we use a discount factor or not?
– Should we use a discount factor or not?
- Value of goods is not less because it is later in
time
+ Assets saved now grow with the real interest rate
in time and are thus worth more in the future
• What defines a sustainable path?
1. Outcome oriented
• Utility calculations
2. Capital oriented
• Capital stock calculations
• What defines a sustainabile path?
1. Outcome oriented
• Utility calculations
– Representative agent
[ ]U t
[ ]
0
dU t
dt
≥ • Utility not decreasing
• Ramsey (or Solow) model?
– Remember macroeconomics
– Are the outcomes sustainable?
[ ][ ] dt
MaxU C t e−
(1 ) ( )t t t tsuchthat K K Y Cδ= − + −&
tY
[ ]C t
t
Yes
• Ramsey (or Solow) model?
– Remember macroeconomics
– Are the outcomes sustainable?
[ ][ ] dt
MaxU C t e−
(1 ) ( )t t t tsuchthat K K Y Cδ= − + −&
tY
[ ]C t
t
No
• Ramsey (or Solow) model?tY
[ ]C t
t
Sustainable
• What is drawback of this approach?
• We only talk about utility -> human satisfaction is the
focal center.
• No mention of natural stocks.
• What defines a sustainable path?
1. Outcome oriented
• Utility calculations
2. Capital oriented
• Capital stock calculations
• What is capital?
– Man-made capital Km
– Human capital Kh
– Natural captital Kn
– Social capital Ks
• Weak sustainability
• Different sorts of capital are substitutable.
M H N
t t t tK K K K= + + 0tdK
dt
≥
• John Hartwick (1977, AER) “
Intergenerational equity and the investing of rents fro
”
• Rules for “Weak sustainability
• Does the consumption of non-renewable assets
imply a decrease in consumption?
– Oil, gas, coal extracted and burned
– Forests, pristine nature replaced by cities
• If the capital stock is kept constant, consumption
may not decrease.
M H N
t t t tK K K K= + + 0tdK
dt
≥
• What should Saudi-Arabia do to be weakly
sustainable?
– Extracting oil
– Invest the rents in human and man-made
capital
– Do they do this?
• Not really
• What oil and gas country is weakly
sustainable?
– Norway
– Rents are invested in the “oil fund”.
• What is the drawback of this definition of
sustainability?
• We may want to keep a stock of pristine
nature
• Problem with weak sustainability
– Assumes perfect substitution between
different forms of capital
• Weak sustainability
• Different sorts of capital are substitutable.
M H N
t t t tK K K K= + + 0tdK
dt
≥
• Strong sustainability
0
N
tdK
dt
≥ 0
N
N N t
t
dK
K K and
dt
′
′ ′⊂ ≥or
No reduction in
natural assets!
• A subset of the natural assets is
deemed essential
• May not be degraded!
Examples:
• The ozon layer
• Amazon forest
• Global temperature
0
N
N N t
t
dK
K K and
dt
′
′ ′⊂ ≥
• A subset of the natural assets is
deemed essential
• May not be degraded!
• What is this the essential subset of the natural assets?
• Possible answers:
1. Existing level
2. “Level consistent with the critical level”
3. (Something in between)
• Possible answers:
• Suppose we have an answer to this (we set some level)
– For global temperature
– For fish stocks
– For pristine forest
• How do we measure such a level?
– Should they be measured in physical or
monetary units?
• Physical: Aggregation problem
– How to aggregate the different elements of KN?
» oak tree + a blue whale?
– Category woodlands:
» Is a sitka pruce as valuable as native Scots pine or
an ancient oak?
• Monetary:
– How much is a human’s life and how much that of a
whale, a tree or fresh air?
• “Mother ship earth”
• environment - economic system is a
closed system.
• first law of thermodynamics
– energy and matter can neither be created nor
destroyed
• second law of thermodynamics (entropy
law)
– entropy increases
– Entropy is a measure of disorder
• How to diminsh pollution
– In an as efficient as possible way?
• Applied on carbon emissions
by the electricity sector in the
EU:
–How to create a framework that
leads to cleaner electricity?
2mT 4mT 5mT
A B C
Emissions:
2mT 4mT 5mT
A B C
Emissions:
4$/T 5$/T 20$/T
Abatement
cost:
2mT
A B C
4$/T 5$/T 20$/T
Abatement
cost:
Abatement
-investment
7$/T
5mT4mT1mT
1$/T
Emissions:
A B C
Abatement
cost:
Abatement
-investment
?
Emissions:
A B C
Abatement
cost:
Abatement
-investment
Emissions:
A B C
EMISSION PERMIT MARKET
Competition
for
permits
Solution 1:
EU Emission Trading Scheme (EU-ETS)
• 2005- end 2007: Phase 1 (test phase)
• 2007- end 2012: Phase 2 (6.5% below 2005 level)
• 2012- end 2020: Phase 3 (linear 1.74% reduction/year)
Kyoto Protocol
Reduction of 21%
• Qm is the chosen
quantity of
production
• A+B+D= profit
• B+D+C= external
costs.
• Q* is the optimal
level of production
– Implying an
optimal level of
pollution
• How to improve
this outcome?
– Tax
– Set property
rights and leave
to bargaining
• Lecture 1 finish
• Coase Theorem
• Coase (1960):
Set property
rights and leave
to bargaining
1. Polluter has
property rights
– Victim suffers
cost B+D+C at
Qm
– Victim offers
bϵ[D,C+D] to
produce at Q*
• Coase (1960):
Set property
rights and leave
to bargaining
2. Victim has
property rights
– Polluter
produces 0
– Polluter offers
bϵ[B,A+B] to
victim to
produce at Q*
• What are the assumptions of the Coase
Theorem (1960)?
– No transaction costs!
• Cost of the effort of contracting
• Free riding problems
• Not a general equilibrium approach -> Wealth
effects may affect preferences.
Debreu & Arrow, 1954. Existence of an Equilibrium
for a Competitive Economy, Econometrica.
• Coase theorem is a special case of a general
equilibrium.
• Examples
1. Does an externality exist? Positive or
negative?
2. Does the Coase theorem apply?
3. If Coase theorem does not apply which
government tools are best
1. quantity regulation
2. taxes/subsidies
3. tradeable
1. British Petroleum drills for oil in the gulf coast
2. Carbon emissions from vehicles
3. Your upstairs neighbors throwing an awesome,
but loud party
4. Buying a car with added safety features that
prevent the drivers/passengers deaths in the
event of an accident
5. Bringing crying babies on a plane
1. Does an externality exist? Positive or negative?
2. Does the Coase theorem apply?
3. If Coase theorem does not apply which government
tools are best
1. quantity regulation
2. taxes/subsidies
3. tradeable
• An natural gas company in San Francisco
owns many pipelines running underneath
what is now populated areas.
• The company can invest $u in the
maintenance of the pipes. Maintenance
affects two things:
– less gas lost. Value of lost gas = 1/u
– less damage to land above the pipes. Value
of damage = 3/u
• Externality?
• What is the social optimum?
• The social optimum minimizes total costs:
–Value of lost gas = 1/u
–Value of damage = 3/u
The social optimum?
• Optimal maintenance is u*=2
• The value of lost gas is ½
• Value of nature damage is 3/2.
• Total costs are: 2 + ½ + 3/2 = 4
• The gas company will solve:
–Value of lost gas = 1/u
–Value of damage = 3/u
No owner of the land?
• Private maintenance is uP=1
• The value of lost gas is 1
• Value of land damage is 3.
• Total costs are: 1 + 1 + 3 = 5
• In the social optimum, the social costs were 4.
• Thus, there is a deadweight loss: 5-4= 1.
• Suppose now that the gas company owns
the land above the pipes.
• What level of u will they choose now?
• Is this optimal?
• The gas company will solve:
–Value of lost gas = 1/u
–Value of damage = 3/u
Joint ownership of gas
and land
• This is optimal
• Thus, there is no deadweight loss
• Suppose now that Jimmy Fallon, an ordinary
private citizen, owns the property above the
plant and can costlessly sue the natural gas
company for the losses to his property.
• What level of u will be chosen by the natural gas
company?
• How much will be paid from the gas company to
Jimmy Fallon?
• The lawsuit imposes a cost on the gas company
• How large?
– P(u)= 3/u
• The gas company will solve:
–Value of lost gas = 1/u
–Value of damage = 3/u
Costless enforcement of
property right by land
owner
• This is optimal
• Thus, there is no deadweight loss
• The company pays 3/2 to Jimmy
• No dealing
• What level of u is chosen by the gas company
when no one owns the land above the pipes?
• Now what is the value of lost gas? What is the
value of land damage?
• The gas company will solve:
• What if the courts are imperfect?
• For every $1 in actual damage, only 50%
of the damage can be recouped in court.
• So, if the true damage to Jimmy is L, the
gas company will only pay L/2
• The gas company will solve:
–Value of lost gas = 1/u
–Value of damage = 3/u
Only half of property
right can be enforced by
land owner
• The social costs are now
• DWL =
• Suppose the gas company owns the
property. What level of u will be chosen?
Is this efficient?
• Why does ownership make a difference
here? Coase theorem says it shouldn’t
make a difference
• No perfect property rights (can only be
enforced for only 50% )
• Extra exercises
• Two power plants provide power to all of
Cambridge: an MIT plant and a Harvard plant.
Both power plants burn coal to produce
electricity, and consequently produce smog as a
by-product.
• The MIT power plant could reduce its smog by
xM at a total cost of:
• The Harvard power plant could reduce its smog
by xH at a total cost of:
• The Cambridge government hires a team
of environmentalists who calculate that the
total benefit of smog abatement to the city
of Cambridge is
Costs:
Benefit:
What is the socially optimal level of abatement?
Social
optimum
• The Cambridge government considers
imposing a tax on power production.
• What tax should it impose to reach the
socially optimal abatement?
Socially optimal level of abatement:
What tax reaches the socially optimal abatement?
• What is the marginal damage?
• -100 -> Set tax=100 per unit of production
Costs:
Benefit:
Taxing
• Suppose that instead of taxation, the
Cambridge government tries to regulate
quantities.
• However, the city of Cambridge cannot
write a law for each firm, so it simply
declares that all Cambridge power plants
must cut down on smog by xC= 1 units
each year.
• How suboptimal is this?
Socially optimal level of abatement:
Compare marginal costs of reduction:
• M: MC=10 x 1 = 10
• H: MC= 14 x 1 +10 = 24
Costs:
Benefit:
Reduce each
by 1 unit
• Suddenly, an economist is voted in as Mayor of
Cambridge.
• She declares that each Cambridge power plants
must cut down on smog by 5 units.
• However, she declares that firms will be able to
competitively 5 trade permits that will allow them
NOT to abate.
• She grants MIT 5 permits and Harvard 0
permits.
• As a result, Harvard is expected to abate by 5
units, and MIT nothing.
• Assume that MIT and Harvard act as perfectly
competitive permit traders
Socially optimal level of abatement:
Costs:
Benefit:
Reduce by 5
units in total,
trade 5
permits
2
: (5 ) 5(5 )M MM Max p y y× − − −
2
: 7(5 ) 10(5 )Hy H H HH Min y y p y− + − + ×
Let: be the amount of permits M holds
be the amount of permits H holds
M
H
y
y
2
: (5 ) 5(5 )My M MM Max p y y× − − −
10(5 ) 0
50 10
10 50
5
10
M
M
M
M
p y
p y
y p
p
y
− + − =
= −
= −
= −
2
: 7(5 ) 10(5 )Hy H H HH Min y y p y− + − + ×
14(5 ) 10 0
70 14 10 80 14
80
14
H
H H
H
y p
p y y
p
y
− − − + =
= − + = −
−
=
5
10
M
p
y = −
80
14
H
p
y
−
= 5 M Hy y≡ +
800 100
24 3
80
5 5
10 14
80
10 14
14 800 10
24 800
33.3
p p
p p
p p
p
p
−
− + =
−
⇔ =
⇔ = −
⇔ =
⇔ = = =
Costs:
Benefit:
Reduce by 5
units in total,
trade 5
permits
33.33
5 1.67
10
My = − =
80 33.33
14
Hy
−
=
MMC = 33.33
HMC = 14 1.67 10× +
23.33 10= +
33.33=
46.67
3.33
14
= =
Is this optimal?
5 ie454  l1_ sustainability & externalities
5 ie454  l1_ sustainability & externalities

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5 ie454 l1_ sustainability & externalities

  • 2. Lecture Moderate A. Sustainability 1 21.09 What is "sustainability"? Externatilites. Hanley Ch.2, Tietenberg Ch 2 2 29.09 Market failure Tietenberg Ch 2 3 05.10 Global warming Tietenberg Ch 16 4 12.10 First-best optimal instruments Second-best instruments (subsidies) Tietenberg Ch 14 Cramton 5 19.10 Optimal extraction of exhaustible sources: the basic model & extensions Tietenberg, Ch.5 B. Fossil fuels: Oil, Gas & Coal 6 26.10 Oil. Security of supply. Shale oil, oil shale (kerogen), tar sands (bitumen). Peak oil, Huber curves and reserves BP BP 2013 Edwards p.68-92, 126-157 IER Smil: Memories of peak oil Smil 2010: power density primer 7 02.11 Gas. Security of supply: short-term & long-term. The crucial difference between oil and gas. Bilateral monopoly. "pipe wars". Shively-GAS, Chap 1, 2, 10 Ratner Shively-GAS Stern
  • 3. C. Electricity markets 8 09.11 Fundamentals of electricity: The system Shively-E Ch.1, 2, 4, 5, 6, 7. Biggar Ch. 2 9 16.11 Fundamentals of electricity: Generation Shively-E Ch. 4. Edwards p.93-112 +117 (California) 10 23.11 Generation: Trading simulation 1a & 1b Edwards p.259-271 Stoft p.33-45, 123-129 11 30.11 Generation: optimal investment, screen curves, load duration curve, missing money & capacity payments and subsidies Stoft p.33-45, 123-129 D. Climate policy 12 07.12 Renewable energy sources: - costs & benefits - the costs of intermittency - LCOE and its drawbacks - the utility dead-spiral Borenstein 2012 Marcantonini Taylor Boehringen Hirth Smil 2010 Smil 2014 Reader 13 14.12 E. Enviromental survival: Past and future - The Green paradox - Disasters, myths and miracles Tietenberg, Ch.5 Morris Wilson 17.12 Exam for exchange students (not for "domestic" ones)
  • 5. • What is sustainability?
  • 6. • What is sustainability? – Utilitarian approach: look at the discounted sum of well-being of all people over time. – Kantian approach: Future generations have moral rights to a level of well-being no less than our own. – Should we use a discount factor or not?
  • 7. – Should we use a discount factor or not? - Value of goods is not less because it is later in time + Assets saved now grow with the real interest rate in time and are thus worth more in the future
  • 8. • What defines a sustainable path? 1. Outcome oriented • Utility calculations 2. Capital oriented • Capital stock calculations
  • 9. • What defines a sustainabile path? 1. Outcome oriented • Utility calculations – Representative agent [ ]U t [ ] 0 dU t dt ≥ • Utility not decreasing
  • 10. • Ramsey (or Solow) model? – Remember macroeconomics – Are the outcomes sustainable? [ ][ ] dt MaxU C t e− (1 ) ( )t t t tsuchthat K K Y Cδ= − + −& tY [ ]C t t Yes
  • 11. • Ramsey (or Solow) model? – Remember macroeconomics – Are the outcomes sustainable? [ ][ ] dt MaxU C t e− (1 ) ( )t t t tsuchthat K K Y Cδ= − + −& tY [ ]C t t No
  • 12. • Ramsey (or Solow) model?tY [ ]C t t Sustainable • What is drawback of this approach? • We only talk about utility -> human satisfaction is the focal center. • No mention of natural stocks.
  • 13. • What defines a sustainable path? 1. Outcome oriented • Utility calculations 2. Capital oriented • Capital stock calculations • What is capital? – Man-made capital Km – Human capital Kh – Natural captital Kn – Social capital Ks
  • 14. • Weak sustainability • Different sorts of capital are substitutable. M H N t t t tK K K K= + + 0tdK dt ≥
  • 15. • John Hartwick (1977, AER) “ Intergenerational equity and the investing of rents fro ” • Rules for “Weak sustainability • Does the consumption of non-renewable assets imply a decrease in consumption? – Oil, gas, coal extracted and burned – Forests, pristine nature replaced by cities • If the capital stock is kept constant, consumption may not decrease. M H N t t t tK K K K= + + 0tdK dt ≥
  • 16. • What should Saudi-Arabia do to be weakly sustainable? – Extracting oil – Invest the rents in human and man-made capital – Do they do this? • Not really • What oil and gas country is weakly sustainable? – Norway – Rents are invested in the “oil fund”.
  • 17. • What is the drawback of this definition of sustainability?
  • 18.
  • 19.
  • 20.
  • 21.
  • 22. • We may want to keep a stock of pristine nature • Problem with weak sustainability – Assumes perfect substitution between different forms of capital
  • 23. • Weak sustainability • Different sorts of capital are substitutable. M H N t t t tK K K K= + + 0tdK dt ≥ • Strong sustainability 0 N tdK dt ≥ 0 N N N t t dK K K and dt ′ ′ ′⊂ ≥or No reduction in natural assets! • A subset of the natural assets is deemed essential • May not be degraded! Examples: • The ozon layer • Amazon forest • Global temperature
  • 24. 0 N N N t t dK K K and dt ′ ′ ′⊂ ≥ • A subset of the natural assets is deemed essential • May not be degraded! • What is this the essential subset of the natural assets? • Possible answers: 1. Existing level 2. “Level consistent with the critical level” 3. (Something in between) • Possible answers: • Suppose we have an answer to this (we set some level) – For global temperature – For fish stocks – For pristine forest
  • 25. • How do we measure such a level? – Should they be measured in physical or monetary units? • Physical: Aggregation problem – How to aggregate the different elements of KN? » oak tree + a blue whale? – Category woodlands: » Is a sitka pruce as valuable as native Scots pine or an ancient oak? • Monetary: – How much is a human’s life and how much that of a whale, a tree or fresh air?
  • 26.
  • 27.
  • 28. • “Mother ship earth” • environment - economic system is a closed system. • first law of thermodynamics – energy and matter can neither be created nor destroyed • second law of thermodynamics (entropy law) – entropy increases – Entropy is a measure of disorder
  • 29. • How to diminsh pollution – In an as efficient as possible way?
  • 30. • Applied on carbon emissions by the electricity sector in the EU: –How to create a framework that leads to cleaner electricity?
  • 31. 2mT 4mT 5mT A B C Emissions:
  • 32. 2mT 4mT 5mT A B C Emissions: 4$/T 5$/T 20$/T Abatement cost:
  • 33. 2mT A B C 4$/T 5$/T 20$/T Abatement cost: Abatement -investment 7$/T 5mT4mT1mT 1$/T Emissions:
  • 35.
  • 37. A B C EMISSION PERMIT MARKET Competition for permits Solution 1: EU Emission Trading Scheme (EU-ETS)
  • 38. • 2005- end 2007: Phase 1 (test phase) • 2007- end 2012: Phase 2 (6.5% below 2005 level) • 2012- end 2020: Phase 3 (linear 1.74% reduction/year) Kyoto Protocol
  • 40.
  • 41. • Qm is the chosen quantity of production • A+B+D= profit • B+D+C= external costs. • Q* is the optimal level of production – Implying an optimal level of pollution
  • 42. • How to improve this outcome? – Tax – Set property rights and leave to bargaining
  • 43.
  • 44. • Lecture 1 finish
  • 46. • Coase (1960): Set property rights and leave to bargaining 1. Polluter has property rights – Victim suffers cost B+D+C at Qm – Victim offers bϵ[D,C+D] to produce at Q*
  • 47.
  • 48. • Coase (1960): Set property rights and leave to bargaining 2. Victim has property rights – Polluter produces 0 – Polluter offers bϵ[B,A+B] to victim to produce at Q*
  • 49. • What are the assumptions of the Coase Theorem (1960)? – No transaction costs! • Cost of the effort of contracting • Free riding problems • Not a general equilibrium approach -> Wealth effects may affect preferences. Debreu & Arrow, 1954. Existence of an Equilibrium for a Competitive Economy, Econometrica. • Coase theorem is a special case of a general equilibrium.
  • 51. 1. Does an externality exist? Positive or negative? 2. Does the Coase theorem apply? 3. If Coase theorem does not apply which government tools are best 1. quantity regulation 2. taxes/subsidies 3. tradeable
  • 52. 1. British Petroleum drills for oil in the gulf coast 2. Carbon emissions from vehicles 3. Your upstairs neighbors throwing an awesome, but loud party 4. Buying a car with added safety features that prevent the drivers/passengers deaths in the event of an accident 5. Bringing crying babies on a plane 1. Does an externality exist? Positive or negative? 2. Does the Coase theorem apply? 3. If Coase theorem does not apply which government tools are best 1. quantity regulation 2. taxes/subsidies 3. tradeable
  • 53.
  • 54. • An natural gas company in San Francisco owns many pipelines running underneath what is now populated areas. • The company can invest $u in the maintenance of the pipes. Maintenance affects two things: – less gas lost. Value of lost gas = 1/u – less damage to land above the pipes. Value of damage = 3/u • Externality? • What is the social optimum?
  • 55. • The social optimum minimizes total costs: –Value of lost gas = 1/u –Value of damage = 3/u The social optimum? • Optimal maintenance is u*=2 • The value of lost gas is ½ • Value of nature damage is 3/2. • Total costs are: 2 + ½ + 3/2 = 4
  • 56. • The gas company will solve: –Value of lost gas = 1/u –Value of damage = 3/u No owner of the land? • Private maintenance is uP=1 • The value of lost gas is 1 • Value of land damage is 3. • Total costs are: 1 + 1 + 3 = 5 • In the social optimum, the social costs were 4. • Thus, there is a deadweight loss: 5-4= 1.
  • 57. • Suppose now that the gas company owns the land above the pipes. • What level of u will they choose now? • Is this optimal?
  • 58. • The gas company will solve: –Value of lost gas = 1/u –Value of damage = 3/u Joint ownership of gas and land • This is optimal • Thus, there is no deadweight loss
  • 59. • Suppose now that Jimmy Fallon, an ordinary private citizen, owns the property above the plant and can costlessly sue the natural gas company for the losses to his property. • What level of u will be chosen by the natural gas company? • How much will be paid from the gas company to Jimmy Fallon? • The lawsuit imposes a cost on the gas company • How large? – P(u)= 3/u
  • 60. • The gas company will solve: –Value of lost gas = 1/u –Value of damage = 3/u Costless enforcement of property right by land owner • This is optimal • Thus, there is no deadweight loss • The company pays 3/2 to Jimmy
  • 61. • No dealing • What level of u is chosen by the gas company when no one owns the land above the pipes? • Now what is the value of lost gas? What is the value of land damage? • The gas company will solve:
  • 62. • What if the courts are imperfect? • For every $1 in actual damage, only 50% of the damage can be recouped in court. • So, if the true damage to Jimmy is L, the gas company will only pay L/2
  • 63. • The gas company will solve: –Value of lost gas = 1/u –Value of damage = 3/u Only half of property right can be enforced by land owner • The social costs are now • DWL =
  • 64. • Suppose the gas company owns the property. What level of u will be chosen? Is this efficient? • Why does ownership make a difference here? Coase theorem says it shouldn’t make a difference • No perfect property rights (can only be enforced for only 50% )
  • 66. • Two power plants provide power to all of Cambridge: an MIT plant and a Harvard plant. Both power plants burn coal to produce electricity, and consequently produce smog as a by-product. • The MIT power plant could reduce its smog by xM at a total cost of: • The Harvard power plant could reduce its smog by xH at a total cost of:
  • 67. • The Cambridge government hires a team of environmentalists who calculate that the total benefit of smog abatement to the city of Cambridge is
  • 68. Costs: Benefit: What is the socially optimal level of abatement? Social optimum
  • 69. • The Cambridge government considers imposing a tax on power production. • What tax should it impose to reach the socially optimal abatement?
  • 70. Socially optimal level of abatement: What tax reaches the socially optimal abatement? • What is the marginal damage? • -100 -> Set tax=100 per unit of production Costs: Benefit: Taxing
  • 71. • Suppose that instead of taxation, the Cambridge government tries to regulate quantities. • However, the city of Cambridge cannot write a law for each firm, so it simply declares that all Cambridge power plants must cut down on smog by xC= 1 units each year. • How suboptimal is this?
  • 72. Socially optimal level of abatement: Compare marginal costs of reduction: • M: MC=10 x 1 = 10 • H: MC= 14 x 1 +10 = 24 Costs: Benefit: Reduce each by 1 unit
  • 73. • Suddenly, an economist is voted in as Mayor of Cambridge. • She declares that each Cambridge power plants must cut down on smog by 5 units. • However, she declares that firms will be able to competitively 5 trade permits that will allow them NOT to abate. • She grants MIT 5 permits and Harvard 0 permits. • As a result, Harvard is expected to abate by 5 units, and MIT nothing. • Assume that MIT and Harvard act as perfectly competitive permit traders
  • 74. Socially optimal level of abatement: Costs: Benefit: Reduce by 5 units in total, trade 5 permits 2 : (5 ) 5(5 )M MM Max p y y× − − − 2 : 7(5 ) 10(5 )Hy H H HH Min y y p y− + − + × Let: be the amount of permits M holds be the amount of permits H holds M H y y
  • 75. 2 : (5 ) 5(5 )My M MM Max p y y× − − − 10(5 ) 0 50 10 10 50 5 10 M M M M p y p y y p p y − + − = = − = − = −
  • 76. 2 : 7(5 ) 10(5 )Hy H H HH Min y y p y− + − + × 14(5 ) 10 0 70 14 10 80 14 80 14 H H H H y p p y y p y − − − + = = − + = − − =
  • 77. 5 10 M p y = − 80 14 H p y − = 5 M Hy y≡ + 800 100 24 3 80 5 5 10 14 80 10 14 14 800 10 24 800 33.3 p p p p p p p p − − + = − ⇔ = ⇔ = − ⇔ = ⇔ = = =
  • 78. Costs: Benefit: Reduce by 5 units in total, trade 5 permits 33.33 5 1.67 10 My = − = 80 33.33 14 Hy − = MMC = 33.33 HMC = 14 1.67 10× + 23.33 10= + 33.33= 46.67 3.33 14 = = Is this optimal?