Lecture 9 - Interventions of Goverment

THAI NGUYEN UNIVERSITY OF AGRICULTURE AND FORESTRY
ADVANCED EDUCATION PROGRAM (AEP)
Natural resource economics

LECTURE 9. Command & Control Policies for the
environment
Do Xuan Luan, Phd

Faculty of economics and rural development, TUAF
17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 1

List of all lectures
1. Introduction
2. Externalities
3. Market failure, its causes and suggestions to correct
4. Economics of Pollution
5. Environmental costs
6. Valuing environmental Benefits- Revealed Preference Method
7. Valuing environmental Benefits- State Preference Method
8. Cost-Benefit Analysis (CBA)
9. Interventions of Government
10. Review & discussions
17/09/2022 Do Xuan Luan, PhD, Ferd/TUAF 2

Learning outcome
After this lecture, students should be able to:
1. Understand the main ideas of Coase theorem
2. Understand the main ideas of Property Rights and Liability law
3. Understand the main ideas of the Setting of Standards
4. Understand the main ideas of voluntary Actions
5. Understand the main ideas of trade Permission (Cap and Trade)
6. Take at least one example for each tools of government

interventions

Content
1. Coase theorem
2. Property Rights and Liability law
3. The Setting of Standards
4. Transferable Discharge Permit
5. Voluntary Actions

The Coase Theorem
• “In a world with no transaction costs…where bargain and negotiation is
possible and the property rights are specific, it does not matter who has the
property rights or who is liable for the externalities, the result of the assignment
of the resources will maximize the value of production (The Coase Theorem).
• “..in a world of perfect competition, perfect information and zero transaction

costs, the allocation of resources in the economy will be efficient and will be
unaffected by legal rules regarding the initial impact of costs resulting from
externalities (Regan, 1972, p.427).

An example of The Coase Theorem
• Suppose that these two are located next to each other, divided by
a thin wall.
a doctor
ቊ
a factory
• The doctor needs silence in order to take care his patients.
• The factory needs to be able to turn on the machinery and make

noise.

An example of The Coase Theorem
* We start bargaining over the right whether the doctor can have silence or the
factory can make noise.
+) If there is silence, the doctor will make $400 and the factory will earn nothing
because it can not use the machinery
+) If there is noise, the doctor will not earn anything because he can not have his
patients with that noise and the factory will earn $800.
+) In this case, we would prefer to have noise because the total surplus when the
factory is able to work is bigger than the doctor’s surplus when there is silence.
Doctor Factory
Silience $400 $0
Noise $0 $800
The goal is to maximize the value of production, so it is not relevant who does what.

An example of The Coase Theorem (conti.)
• Not let’s assume that the property rights are established in a way that the doctor
has the right for silence. The doctor could have his silence and earn $400, but in
this case, the factory values noise more than the doctor values silence.
• Because they are able to negotiate without any cost, the factory is going to offer the
doctor at least $400 to let it be noise.
• Let assume that the F transfers $450 to the D. Now, the doctor has $450 and the
factory has $350. The total value of production is still 800. They are both happy
because the doctor has $450 in stead of $400 and the factory has $350 in stead of
$0. Notice that even though the doctor had the right to silence, the efficient
outcome is noise.
Doctor Factory
Silience $400 $0
Noise $450 $350
(400+450) (800-450)
17/09/2022
Outcome: Factory 350 + Doctor 450= 800 8
Do Xuan Luan, Phd, Ferd/TUAF
An example of The Coase Theorem (conti.)
• Now let’s assume that the property rights are established in a way that the factory has
the right to make noise. In this case, the D does not have enough money to pay the
factory to stop the noise. The result will be that the doctor will earn $0 and the factory
will earn $800. Again, the efficient outcome is noise.
• Notice that it does not matter who are assigned the right, the efficient outcome will be
the same.
• This is possible because they can negotiate and there is no cost in doing that.
Doctor Factory
Silience $400 $0
Noise $0 $800
Outcome: Factory 800 + doctor 0 = 800

In real life
• But be careful to take into account that as individuals, they would like to have
the right, because it gives them more income even though it does not change
the efficient outcome. If the D has the right, he will earn 450, if the F has the
right, it will earn 800.
• What happen in real life?
• The costs of transaction are not zero.
• The property rights does have an effect on the efficiency on which the
economic system operates, it will change the value of production and the
way resources are used.

The Coase Theorem
 The Coase Theorem implies that once property rights are

established, no government intervention is necessary.
 The distribution of income in the final outcome will vary based on

who is assigned the rights.
 The Coase Theorem doesn't simply mean that assigning property

rights to a polluter will cause the pollution to continue. A deal
could be struck among both parties to bring about a more desirable
solution.
 However, the decision on property rights will affect the distribution

of income in the final outcome.

The Coase Theorem: main points
• Externalities are reciprocal in nature.
• Not only does the pollution cause an externality, but also

the presence of the victims harms the polluter.
• If no one were harmed, there would be no problem.
• Since externalities are reciprocal, Coase argues that the

highest value option should be preserved.

Several limitations to the Coase Theorem
1. Costs of bargaining and transactions costs

o Negotiation won't work when large numbers of people are involved,
or when the victims aren't well defined (e.g. endangered species).
o Similarly, different groups may have different bargaining power,

affecting the distribution of the final outcome.
2. Need to be able to clearly establish who causes the harm.
3. Willingness to pay and willingness to accept are different.
4. Will victims have sufficient information?

PROPERTY RIGHTS
• Which ones are really causing damage and which ones suffering
damages?
• Who effectively owns the property rights to the lake (the river, the
garden, ….)? When a resource has no owner, nobody has a very
strong incentive to see to it that is not over exploited or degraded in
quality.
• The problem of the misuse of many environmental assets comes

about because of imperfectly specified property rights in those assets.

PROPERTY RIGHTS: Example (1)
Suppose the marginal damage
function refers to all the damages
suffered by the brewery- call this
Firm A.
Marginal abatement cost curve
applies to the firm emitting effluent
into the lake – call this one Firm B.
We have to make some assumption
about who owns the lake, firm A or
firm B?

PROPERTY RIGHTS: Example (2)
• If firm B owns the lake, it may use

the lake any way it wishes. The
emission level could be at e1 –
firm B tend to not devote
resources to emissions
abatements. Firm A might offer
firm B some amount of money to
reduce its effluent stream.
• If the ownership of the lake is
vested in firm A, the firm that is
damaged by pollution. In this
case, firm B needs to buy
permission from Firm A to place
its wastes in the lake. The
emission level into the lake would
be the efficient level e*.

PROPERTY RIGHTS: Principle
$ MAC-Marginal abatement costs

MD-Marginal damages-
(firm B)
firm A
0 e* e1: uncontrolled emission Emissions
level (tons/year)
• Conclusion: if the property rights over the environmental asset are

clearly defined, and bargaining among owners is allowed, the
efficient level of effluent will result irrespective of who was initially
given the property right.
PROPERTY RIGHTS: Conclusion
• The strongest feature of a property right system is that it gives owners

the incentive to protect and manage their assets so as to maximize their
market value.
• For this result in socially efficient levels of resouce use, property rights
must be well defined and defensible,
• Transaction costs must be reasonable low and;
• There must exist markets through which the owners can actually realize
the full social values of their decisions.

PROPERTY RIGHTS: Rules and conditions
• Three conditions need to be met such that a property rights approach

work right:
1. Property rights must be well defined, enforceable, and transferable
2. A reasonably efficient and competitive system for interested parties to

come together and negotiate about how these environmental property
rights will be used.
3. A complete set of markets so that private owners may capture all

social values associated with the use of an environmental asset.
If firm A cannot keep firm B from doing whatever the latter wishes,
of course a property rights approach will not work.

Reasonable low transaction costs
• Transaction Costs = Negotiating costs + the costs of policing the

aggreement.
• Aggreement can be reached if transacion costs are low enough
• Infeasible when so many transactions such as if there are more than 50, 000
people who use the lake as a water supply and for recreation purposes and
1,000 polluting firms.
• High transaction costs will seriously reduce the potential of the private
property approach to idenfity the efficient level of emissions.
• There must exist markets through which the owners can actually realize the
full social values of their decisions.

Liability Law (Trách nhiệm pháp lý)
 Liability laws internalize the externality.
 An example of how the Coase Theorem applies to environmental

policy is liability law.
o If a firm will be held liable for the damages from its pollution, it has
incentive to avoid pollution when the marginal abatement cost is less
than the marginal damage.
 By avoiding damage, the firm lowers its liability.
 Note that the government does not need to know the marginal costs of the
firm in order to achieve the desired level of pollution.
 Liability laws hold parties responsible for the negative consequences

of their behavior.
o As a result, liability laws internalize the externality.

Liability Law
 In theory, this can lead to an efficient solution.
o Because we are dealing with uncertainty, we want to model the level

of precaution taken, which affects the probability of an undesirable
outcome.
o Firms weigh the benefits of precaution (reduced marginal damages,

which they must pay if held liable) versus the marginal cost of greater
protection.
 Note that these are social benefits, since the firms are held liable for
all damages.
 Thus, liability leads to the efficient level of precaution.

Liability Law
• Hold parties responsible for the negative consequences of
their behavior.
• Liability laws internalize the externality
• In theory, liability law can lead to an efficient solution

• Firms weigh the benefit of reduced marginal damages vs. the
marginal costs of greater protection.
• Firms are held liable for all damages
• Liability law leads to the efficient level of precaution (reduced marginal

damages which they must pay if held reliable)

Type of liability
Strict liability: the person doing damage is

responsible, whether or not precautions are taken
3 main types
Negligence: the injurer is held responsible only if that

person has taken less than the desirable level of
precaution requires the courts to determine what an
appropriate level of caution is.
Joint and several liability: when the sources of damages can

be several parties. Any one party can be sued for all the
damages.

Pros and cons of liability law
Title
Add your text
Disadvantages
Advantages
Do not need information until
Need to know who cause the
after damages are done
harm and what the damages
This helps deal with monitoring
are
problems that can occur with
toxins

Setting of standards
• Command and control regulation uses the setting of standards.

• A standard is a mandated level of performance that is enforced in law.
• A standard simply makes excessive amounts of pollution illegal.
• Setting the standard
• For any environmental policy, the first question to be addressed is what level of
protection is desired.
• Here, it is important to note that zero pollution is not a reasonable goal. Some
pollution will result from daily activities. The question is how much pollution is
acceptable.
• There are several criteria that can be used.
• Efficiency standard
• Here, the goal is to maximize economic welfare, accounting for the economic costs of pollution.
• To do so, the marginal benefits of increased environmental quality should equal the marginal
costs of reducing pollution.
• If done at an aggregate level, distributional issues will be ignored.

Uses the setting of standards
• A command-and-control (CAC) approach to public policy is one where,

political authorities simply mandate the behavior in law,
• Courts, police, fines, and so on – are necessary to get people to obey the
law.
• CAC relies on standards of various types to bring about improvements in

environmental quality.Three primary types of standards:
1. ambient,
2. emission and
3. technology.
Types of standards: Ambient Standards
• Ambient environmental quality refers to the qualitative dimensions

of the surrounding environment.
• It could be the ambient quality of the air over a particular city or the
ambient quality of the water in a particular river.
• So an ambient standard is a never-exceed level for some pollutant

in the ambient environment.
• Ambient standards are normally expressed in terms of average

concentration levels over some period of time. For example: sulfur
dioxide (SO2) os 80µg/m3.

Ambient Standards (tiêu chuẩn môi trường)
• Regulates the amount of pollutant present in the surrounding (ambient)
environment.
• Examples:
• Parts per million (ppm) of dissolved oxygen in a river
• Sulfur dioxide (SO2) in an airshed
• Ground level ozone levels (ppm)
• Measures are often an average (e.g. over a 24 hour period, or per year)
• This is important, as concentrations vary by time of day and by season

(e.g. due to changes in weather)
• Note that the level itself cannot be directly enforced.
• Rather, the sources of the pollution must be found and regulated to be

sure that the ambient standard is met.
Ambient Standards

Emission standards
• Regulates the level of emissions allowed
• Examples
• Emissions rates (pounds of SO2 per hour)
• Concentration (ppm of biochemical oxygen demand (BOD) in wastewater)
• Total quantity of a pollutant
• Residuals per unit of output (SO2 per kWh of electricity)
• Residual content per unit of output (sulfur content of coal)
• Percentage removal of pollutant (90% of SO2 scrubbed)
• Note that emissions standards do not guarantee a specific ambient level of
pollution
• Weather conditions affect the concentrations
• Human behavior affects pollution levels

Emission standards

Technology standards
• Require polluters to use certain technologies, practices, or techniques.
• Whereas emissions standards require polluters to meet a goal for the level
of pollution, but give the polluter freedom to choose the technology used,
technology standards require a specific technology.
• Examples
• Until 1990, electric utilities were required to install scrubbers with 90%
efficiency ratings.
• U.S. requires catalytic converters in autos
• In the Clean Air Act, the government mandates that the Best Available
Control Technology (BACT) be used.

Organic Vegetable Standards

Economic Analysis of Standards
• Should standards be applied uniformly?
• Standards apply throughout Vietnam. Is it appropriate to have

uniform standards across regions?
• Are the needs of rural and urban areas similar?
• If marginal damages differ across regions, a uniform standard

cannot be efficient in both jurisdictions.
• However, having different standards increases costs to the government.
• Note in this case the issue is variation in the marginal damage

function.

VOLUNTARY ACTIONS
Individuals (including individual firms) engage in pollution-control

behavior in the absense of any formal, legal obligation to do so.
Examples:
1. Car pooling
2. Using public transportation
3. Energy saving appliances;
4. Window and healting all help reduce pollutants.
5. Taking part in Earth Hours 2022.

A review of possible Gov. interventions and
firms’ responses
• Possible Gov. interventions • Three common responses of firms
1. Property Rights and Liability 1. Lower emissions to the level
law covered by the permit
2. The Setting of Standards: 2. Buy additional permits
• Ambient Standards 3. Lower emissions to be able to sell
• Emission standards permit
• Technology standards
3. Voluntary Actions
4. Transferable Discharge Permit

Cap and Trade or Transferable Discharge Permit: general ideas
• A government issues a limited number of annual permits that allow companies
to emit a certain amount of emissions such as carbon dioxide, as a result of
industrial activity
• The government lowers the number of permits each year, thereby lowering the
total emissions cap.
• The permits more expensive. Over time, companies have an incentive to invest
in clean technology as it becomes cheaper than buying permits.
• The cap-and-trade system is sometimes described as a market system that
creates an exchange value for emissions.

Example 1: Emission fee and firm’s response
• Assume that firm has its marginal abatement cost

function:
• MAC=72-3Q
• Q: level of emission
• Suppose: emission fee per ton of emission: 30$/ton
• How the firm response? (level of emission?)

Example 2: Transferable Discharge Permit
• Suppose that firm A and firm B emitt SO2. Current level of emission of
each firm: 60 tons. Total emissions are 120 tons which at a red line
compared to the accepted level (60 tons).
• The government plans to distribute 30 permits to each firm (30

tons/permit certificate).
• Firms are allowed to transfer their permit certificates. Due to different

MAC functions, a transfer market between firm A and firm B works.
• Operation of the market can lead to a price of permit: 20 $/ permit

certificate.
• How both firms respond? (the amount of emission for each firm)

Example 2: Transferable permit
• Suppose that firm A and firm B emitt SO2. Current level of emission of each
firm: 60 tons. Total emissions are 120 tons which at a red line compared to
the accepted level (60 tons). The government plans to distribute 30 permits
to each firm (30 tons/permit certificate). Firms are allowed to transfer their
permit certificates. Due to different MAC functions, a transfer market
between firm A and firm B works.
• Operation of the market can lead to a price of permit: 20 $/ permit

certificate.
• Firm B (Lower MAC) reduces emission level by 40 tons (rather than 30 tons
as a minimum level required by the government). So, the emission level of
firm B: 20 tons and firm B can sell out 10 tons of its permit certificate

Example 2: Transferable permit
• On the other hand, firm A (higher MAC) decides to buy 10 tons of
emission permission so that it can emitt a total of 40 tons. And,
firm B only needs to treat 20 tons of emission.
• Total abatement social costs has been reduced. Both A and B
benefits from the transferable emission permits.

Comparation abatement costs before and after transferable
permit transaction
Firm A Firm B
1. Abatement cost before ½*30$*30tons=450$ ½*15$*30tons=225$.
2 Abatement costs after ½*20$*20tons= 200$ ½*20*40tons=

400$
- Revenue from selling 0 20$*10=200$
emission permit
- Expenditure from 20$*10=200$ 0

buying emission permit
3 Total abatement costs 200 + 200 = 400$ 400-200=200$

and emission permit
transactions
4 Total benefit due to 450-400=50$ 225-200=25$

transactions
Transferable permit
• Transferable permit combine advantages from both emission standards and

emission fees
Example 3: Selection between emission standard and emission fee
Marginal abatement cost function of two firms:

• Firm A: MAC1= 6500-50Q1
• Firm B: MAC2= 10000-40Q2
Current level of emission of two firms:
• Firm A: 130 tons/year
• Firm B: 250 tons/year.
Without govermental intervention: both firms emitt 380 tons/year.
Suppose that the government plans to cut down emission by 200 tons/year (a
reduction of 180 tons). The government considers two options:
1. Emission standard: 100 tons/year/firm
2. Emission fee: 4000$/ton
Question: Which option should be applied? (given minimum social abatement

costs)

Options of emission reduction and social costs
Emission standard Emission fee

(100 tons/year) (4000$/ton)
Total emission 30 + 150 = 180 80 + 100=180
reduction
Abatement cost for ½ *1500*30= ½*400*80=

firm A 22500$ 160000$
Abatement cost for ½*6000*150= ½*4000*100=
firm B 450000$ 200000$
Total social cost to 472.500$ 360.000$
reduce emission
Comment:
1. Both options of the government can lead to the same amount of emission
reduction (180 tons).
2. Emission fee helps to save more total social abatement costs: 472.500-
360.000=112.500$/year
Options of emission reduction and social costs
Conclusion:
• Give complete information of MAC for firms: emission fee is a
favourarite option compared to emission standard for several reasons:
1. Higher economic efficient (given the same environmental
efficiency)
2. Fees encourage firms to reduce emissions (apply more advanced
technology, engery savings, water savings, waste treatement…)
3. Revenue from fees can help to finance other environmental
protection projects.

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THAI NGUYEN UNIVERSITY OF AGRICULTURE AND FORESTRY

ADVANCED EDUCATION PROGRAM (AEP)

Natural resource economics

Do Xuan Luan, Phd

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 1

3. Market failure, its causes and suggestions to correct

6. Valuing environmental Benefits- Revealed Preference Method

7. Valuing environmental Benefits- State Preference Method

8. Cost-Benefit Analysis (CBA)

10. Review & discussions

17/09/2022 Do Xuan Luan, PhD, Ferd/TUAF 2

After this lecture, students should be able to:

1. Understand the main ideas of Coase theorem

2. Understand the main ideas of Property Rights and Liability law

3. Understand the main ideas of the Setting of Standards

4. Understand the main ideas of voluntary Actions

5. Understand the main ideas of trade Permission (Cap and Trade)

6. Take at least one example for each tools of government

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 3

2. Property Rights and Liability law

3. The Setting of Standards

4. Transferable Discharge Permit

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 4

• “..in a world of perfect competition, perfect information and zero transaction

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 5

• The doctor needs silence in order to take care his patients.

• The factory needs to be able to turn on the machinery and make

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 6

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 7

Outcome: Factory 800 + doctor 0 = 800

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 9

• What happen in real life?

• The costs of transaction are not zero.

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 10

 The Coase Theorem implies that once property rights are

 The distribution of income in the final outcome will vary based on

 The Coase Theorem doesn't simply mean that assigning property

 However, the decision on property rights will affect the distribution

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 11

• Externalities are reciprocal in nature.

• Not only does the pollution cause an externality, but also

• If no one were harmed, there would be no problem.

• Since externalities are reciprocal, Coase argues that the

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 12

1. Costs of bargaining and transactions costs

o Similarly, different groups may have different bargaining power,

2. Need to be able to clearly establish who causes the harm.

3. Willingness to pay and willingness to accept are different.

4. Will victims have sufficient information?

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 13

• The problem of the misuse of many environmental assets comes

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 14

Suppose the marginal damage

function refers to all the damages

suffered by the brewery- call this

Marginal abatement cost curve

applies to the firm emitting effluent

into the lake – call this one Firm B.

We have to make some assumption

about who owns the lake, firm A or

17/09/2022 Do Xuan Luan, Phd, Ferd/TUAF 15

• If firm B owns the lake, it may use