Economic Solutions to Environmental Problems: The Market Approach

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 i

Economic Solutions to Environmental Problems: The

Market Approach

Chapter 5

© 2004 Thomson Learning/South-Western

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

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

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 Q E

 Assessing the Model

abate pollution

Pollution Charges

Figure 5.1 Implementation of a Pigouvian Tax to Achieve

Efficiency

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

incentives of the polluter

Pollution Charges

Figure 5.2 Modeling an Emission Charge for a Single Firm

Pollution Charges

Figure 5.3 Effect of Technology Improvement on a Firm’s

Least-Cost Decision Making

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

Pollution Charges

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

Model

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

Environmental Subsidies

 Two major types of subsidies:

 Abatement equipment subsidies

 Pollution reduction subsidies

Environmental Subsidies

 Modeling an Abatement Equipment Subsidy

 Abatement equipment subsidy – a payment aimed at

lowering the cost of abatement technology

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 Q E

 Assessing the model

 Difficulty measuring the MEB

 May bias polluters’ decisions about how best to abate

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 determined level

pre- Assessing the Model

in the aggregate

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

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

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

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

without adding to monitoring and compliance costs

materials

Deposit/Refund Systems

Figure 5.5 A Pigouvian Subsidy in the Market for Scrubbers

Deposit/Refund Systems

 Deposit/Refund Systems in Practice

 Beverage container disposal

 Disposal of used tire, car hulks, and lead-acid

batteries

Deposit/Refund Systems

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

Waste Disposal

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

Pollution Permit Trading Systems

 Structure of a Pollution Trading Systems

 Two components:

region

polluting sources within that region

 Bargaining gives rise to a market for pollution rights

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

without intervention

Pollution Permit Trading Systems

 Pollution Trading Systems in Practice

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