Chapter 6

Pollution control-Part 1
 Pollution control
I. Property right approach (Coase
theorem)
II. Command and Control approach
(CAC)
III. Economic incentives approach
(Economic instruments)
I. Property right approach

Coase Theorem

Regardless of who holds the

property rights, there is an automatic Ronald Coase
1991 Nobel Prize in Economics

tendency to approach the social

optimal via bargaining.

(Ronald Coase)
Property Rights-Coase Theorem

• Corollary: efficient allocation does not

depend on initial allocation of property
rights
• Conditions
• “well-defined” property rights
• low transactions costs
 Coase Theorem
• One example to illustrate his theory is based on the interaction of
a chemical factory and fishery both using the same river.
• CASE 1: Chemical company (the polluter) has the property
right to use the river
• CASE 2: The fishery (pollutee) has the property right to use
the river
• Coase argued that the polluter and polutee will reach an
agreement that will make them both better off.
• Either the polluter will accept payment to reduce the size of the
production or pollutee will accept payment to cover the damages.
• And this will happen without government intervention.
Illustration of Coase theorem
Using MNPB and MEC

8
7 2 1

5 4
6 3
Equilibrium the Coase-theorem
+Scenario 1: Polluter has the right to use (pollute) the
environment
• Starting point of bargain: Qp
• End point of bargain: Q*
• Sufferer (pollutee) pays to the polluter
• Minimum: Q*YQp
• Maximum: : Q*YiQp
+Scenario 2: Pollutee has the right for a clean
environment
• Starting point of bargain: 0
• End point of bargain: Q*
• Polluter pays to the sufferer (pollutee)
• Minimum: OYQ*
• Maximum: OaYQ*
Illustration of the Coase theorem
Using MAC and MDC
Equilibrium the Coase-theorem
+Scenario 1: Polluter has the right to use the environment
• Starting point of bargain: E4
• End point of bargain: E*
• Sufferer (pollutee) pays to the polluter
• Minimum: ME*E4
• Maximum: ME*E4B
+Scenario 2: Pollutee has the right for a clean environment
• Starting point of bargain: 0
• End point of bargain: E*
• Polluter pays to the sufferer (pollutee)
• Minimum: OME*
• Maximum: OAME*
 Limitations of the Coase theorem
• Assumes perfect competition

• The identification of the participants of the bargaining

process poses problems:

+ High number of interested parties

+ Identification of those who cause the damage and

those who suffer from it

• Transaction costs are often high

• Only a few practical examples

 Limitations of the Coase theorem
• Another problem associated with the Coase
example can occur when the allocation of
property rights would signal entry and exit in
response to those rights.
• If chemical company has the right to pollute the
river without worrying about paying damages,
then there can be an increase in the number of
chemical companies, and more damages.
Bottom Line on Coase
arguments
• Probably are cases where private
negotiations can be effective
• In those cases, government should stay out
• But, probably plenty of cases where
transaction costs and other issues lead to
need for intervention
12
Types of Government Intervention

ØThere are five broad classes of government

intervention:
• Moral suasion
• Direct production of environmental quality
• Pollution prevention
• Command and control regulations
• Economic incentives
ØEach of these represents a different philosophy
toward the role of government in society.
 Moral Suasion
• Government attempts to influence
behavior without actually stipulating
any rules.
• Effectiveness depends upon the
extent to which individuals believe it
is in their collective interest to do so. 14
15
Direct Production of
Environmental Quality
vIncludes
• Reforestation,
• Stocking of fish,
• Creation of wetlands,
• Treatment of sewage, and
• Toxic waste site cleanup
•…

16
Pollution Prevention
• Designed to address market failure of imperfect
information, in some cases there may be
technologies that could be developed that save
firm’s money and improve environment
• Combined efforts of government agencies, national
laboratories, university and private firms can lead to
development of innovative and beneficial
technologies.
• These programs emphasize being proactive in
reducing pollution, encourage R&D and adoption of
17
“green technologies” .
Command and Control
Regulation
• These place constraints on the behavior of
households and firms.
• Constraints generally take the form of
limits on inputs or outputs in the
consumption or production process.

18
Economic Incentives
Economic incentives make self interest
coincide with social interest
• Pollution taxes
• Pollution subsidies
• Marketable pollution permits
• Deposit-refund systems
• Performance bonds
• Liability systems
• …
II. Command and Control approach

• The dominant method of reducing pollution in

most countries has been the use of direct controls
over polluters.
• This set of controls is commonly known as
command and control instruments
 Ambient pollution
levels

Location of
emissions
Emissions output

Quantity of goods produced

Production technique

Inputs used

The pollution process (Panel a)

 Ambient pollution
requirements

Zoning
Emissions licenses

Output quotas

Technology controls

Input restrictions

Command and control instruments (Panel b)

 Types of standards –
Three types: ambient, emission, technology

vAmbient standards refers to the qualitative dimensions

of the surrounding environment (ambient quality of the
air/city or water quality/river, lake)
• Ambient standards are normally expressed in terms of
average concentration levels over some period of time.
• An ambient standard is a never-exceed level for a pollutant in the
ambient environment

• E.g: The ambient standard for carbon monoxide (CO) from asphalt
recycling plants in British Columbia is 500 mg/m3 for a one-hour
average.
 Emission standards
vAn emission standard is a maximum rate of effluent
discharge that is legally permitted

• Emission standards are never exceed levels applied

directly to the quantities of emissions coming from
sources

EX: grams/unit, tons per week/year

• Setting emission standards at a certain level does not

necessary entail meeting a set of ambient standards.
• Emission standards as a policy tool to control pollution-
Using MNPB and MEC
Emission standards as a policy tool to control pollution-
Using MAC and MDC

W*
Technology, techniques/
practices standards
vTechnology standards dictates
certain decisions and techniques to
be used

vE.g. The requirement that cars be

equipped with catalytic converters,
or seat belts, scrubbers, baghouse is
a technology standard.
III. Economic instruments
2.1 Pigouvian taxes
2.2 Emission charges/taxes
2.3 Subsidies
2.4 Transferable Discharge Permit/Quota
2.5 Deposit-Refund Systems
2.6 Environmental Performance Bonds
Advantages of economic
instruments
• Automatic adjustment: polluters lower
their emissions
• Cost-effectiveness
• Incentive for “environmentally friendly”
behavior
• Flexibility: for both Gov. and polluters
• Revenue raising
• Resource conservation and transmission
Pigouvian Taxes

• The basic principle behind the use of

externality taxes is that the tax eliminates
the divergence between the Marginal
Private Cost (MPC) and the Marginal Social
Cost (MSC).
An Externality Tax on Output

31
 Pigouvian Taxes
MSB(Q*) =MSC(Q*);
MSC(Q*)= MPC(Q*) + MEC (Q*);
MSC(Q*) = MPC’(Q*) = MPC(Q*)+ t*
àMEC(Q*)=t*
= MPC'
t*= MEC (Q*)
T= t* x Q*
 Pigouvian taxes
MNPB and MEC
t*= MEC (Q*)
T= t* x Q*

Pigou tax is the Pollution cost at optimal level of pollution

Some problems with Pigouvian
taxes
External cost: a
Tax: a+b
 Some problems with Pigouvian
taxes

• Taxation is unfair to polluters because they have to pay more

than the external costs they cause (a < (a+b))
• It is difficult to determine the accurate tax rate t* because
there is not enough information about the MNPB and MEC
curves
• (Taxes do not put the level of pollution under direct control
so when there is uncertainty in abatement costs one might
not get the desired level of pollution.)
• Pollution tax is levied on each unit of output without being 35
based on the actual amount of waste emitted
2.2 Emission charges/emission
taxes (pollution taxes)
oEmission charge is a tax (or financial penalty)
imposed on pollution.
oThe essence of the emission tax approach is
to provide an incentive for the polluters
themselves to find the best way to reduce
emissions, rather than having a central
authority determine how it should be done.
Emission charge &
Pigouvian tax
• The emission charge is based on per unit
of effluent emitted to the environment
• The Pigouvian tax is based on per unit of
good or service produced.
Emission charges
• Government sets emission charge = $f per unit of emissions
• Polluter has incentive to reduce emissions until MAC = f*
• Standard at E1 would only cost firm area "b” as abatement
cost; much less than the charges
• Private costs of compliance as the polluter’s total abatement
costs plus its tax bill. (a+b)

$ MAC

Tax bill

f*

c
a b

Emissions
E1 E0

Abatement Cost
 Emission charge
Using MDC & MAC
Optimal f* occurs where MDC = MAC
MDC
Reduced damages = e + f MAC

Remaining damages = b + d

f* f
Emission charge = a + b + c + d
c
a
d e
Social costs of compliance b
include only the real resources E1 E* E0
used to meet the environmental
target; they do not include the
tax bill .(area e)
Incentive to improve waste control technology
Cost MAC0 : Original
Abatement cost: G + H
MAC1 MAC0 Emission charge: D + E + F
Total : DEFGH

MAC1: New
Total D + E + H
Cost saving: F + G

Fk F
G
D E H

Wk =1000 Wm =1500
400

Emission
Emission charge
MNPB and MEC approach
Suppose that society's marginal abatement cost function is given by
MAC = 50 - 2E and society's marginal damage function is given by MDC
= 3E. What is the optimal level of pollution emissions?
a) 50
b) 30
c) 20
d) 10
e) 5
According to the situation above, what would be the
optimal per unit pollution tax?
a) $50
b) $40
c) $30
d) $20
e) $10
 Example
MAC = 90-5W
Emission charge is 28$/unit
What were the efficient emission level?
Calculate the Total Abatement cost and
Total private cost of compliance of emission charge

90-5W*=28
à W* = 12.4 90
TAC(12.4)=(18-12.4)x28/2 MAC
= 78.4
TEC=TAC+Emission charge=
78.4 + 28x12.4 = 425.6 F= 28
28

a b

12.4 18
W
Exercise
A factory producing chemical fertilisers (MNPB=4-0,5q) is
polluting the nearby river, causing environmental damage:
MEC=1,5q.

a. How much will the factory produce to maximise its profit, and
how much profit will it then have?
b. If the goverment decides to regulate the company using a tax,
how high should the tax rate be, how much tax will the company
be paying,and how much profit will it then have?