Targets of Environmental Policy

• Pollution is an externality, that is, the unintended consequence of one‘s production or consumption on somebody else‘s production or consumption • Pollution damage depends on – Assimil

ERE9: Targets of Environmental Policy

• Steady state

• Dynamics

• Alternative targets

Last week

• Valuation theory

• Total economic value

• Indirect valuation methods

– Hedonic pricing

– Travel cost method

• Direct valuation methods

Environmental & Resource

Economics

• Part 1: Introduction

– Sustainability

– Ethics

– Efficiency and optimality

• Part 2: Resource economics

– Valuation (next course)

– International environmental problems (next course)

– Environmental accounting

• Pollution is an externality, that is, the unintended consequence of one‘s production or consumption on somebody else‘s production or consumption

• Pollution damage depends on

– Assimilative capacity of the environment

– Existing loads

– Location

– Tastes and preferences of affected people

• Pollution damage can be

– Flow-damage pollution: D=D(M); M is the flow– Stock-damage pollution: D=D(A); A is the stock– Stock-flow-damage pollution: D=D(M,A)

Economic activity,

residual flows and

environmental damage

Efficient Flow Pollution

dM dB

Maximised net benefits

M *

µ *

M

D(M) B(M)

Total damage and benefit functions

Marginal damage and benefit functions

Marginal damage

Marginal benefit

Costs,

benefits

Quantity of pollution emission per period

M *

A

The economically efficient level of pollution minimises the sum of

abatement and damage costs

M ’

D

X

Y

Types of externalities

• Area B: Optimal level of externality

• Area A+B: Optimal level of net private benefits of the polluter

• Area A: Optimal level of net social benefits

• Area C+D: Level of non-optimal externality that needs regulation

• Area C: Level of net private benefits that are

unwarranted

• M*: Optimal level of economic activity

• M‘: Level of economic activity that maximises

private benefits

Efficient Flow Pollution (2)

• Optimal pollution is greater than zero

• The laws of thermodynamics imply that zero

pollution implies zero activity, unless there are thresholds (e.g., assimilative capacity)

• Optimal pollution is greater than the assimilative capacity

• Pollution greater than the optimal pollution arises from discrepancies between social and private

welfare

Stock pollutants lifetime

pre-industrial concentration

concentration

in 1998

atmospheric lifetime

Sulphur spatially variable spatially variable 0.01-7 days

NO x spatially variable spatially variable 2-8 days

Source: IPCC(WG1) 2001

Stock pollutants with short lifetime:

When location matters

Wind direction

and velocity

Stock pollutants with longer lifetime:

Efficient pollution

D r

Steady State (2)

• Marginal benefit of the polluting activity

equals the net present value of marginal

pollution damages

• Benefits of pollution are current only

• Damages of pollution are a perpetual annuity

• The decay rate ( ) acts as a discount rate

perfectly persistant pollutant

Distinguish four cases:

Steady state: Case A

• Equation collapses to

• In the absence of discounting, an efficiency

steady-state rate of emissions requires that

– the marginal benefits of pollution should equal the marginal costs of the pollution flow

– which equals the marginal costs of the pollution stock divided by its decay rate

Steady state: Case A (2)

In the steady-state, A will have reached a

level at which α A*=M*

r 1 dM dB

Steady State: Cases C and D

state can only be reached if emissions go to zero

positive level of emissions

Efficient Stock-Flow Pollution

• Pollution flows are related to the extraction and use of a renewable resource

non-– For example, brown coal (lignite) mining

• What is the optimal path for the pollutant?

• Two kind of trade offs

– Intertemporal trade-off

– More production generates more pollution

• Pollution damages through

= ( , )

U U C E

− + +

The optimisation problem

• Current value Hamiltonian:

Shadow Price of Resource

• Gross price = Net price + extraction costs + disutility of flow damage + loss of production due to flow damage + value of stock damage

• Flow and stock damages need to be

time, t

Units of utility

Marginal extraction cost

Gross

price

Optimal time paths for the

variables of the pollution model

time, t

Units of utility

Private

costs

A competitive market economy

where damage costs are

internalised

Social

costs

Efficient Clean-up

• The shadow price of capital equals the

shadow price of stock pollution times the marginal productivity of the clean-up

activity

• Ergo, environmental clean-up (defensive

expenditure) is an investment like all other investments

V

Alternative Standards

• Optimal pollution is but one way of setting

environmental standards and not the most

– Safe minimum standards

– Best available technology (not exceeding excessive costs)

– Precautionary principle