Chapter five

Economics of pollution
control
Taxonomy of pollution

Pollution is:
• a side effect of production
• The introduction of ‘waste and harmful
products’ in to an environment
– E.g. greenhouse gases as a result of waste products
that escape into the atmosphere causes:
• the average temperature to rise
• Melting polar ice caps
• sea levels rise and weather patterns can be affected
– As a results of these effects people around the world may
suffer from extraordinary flooding, storms, tornados and
drought
Cont’d
 Two questions must be addressed:
(1) What is the appropriate level of flow? and,
(2) How should the responsibility for achieving this
flow level be allocated among the various sources of
the pollutant when reductions are needed?
• In this chapter we lay the foundation for
understanding the policy
Cont’d
 The amount of waste products emitted
determines the load upon the environment.
 The damage done by this load depends on the
capacity of the environment to assimilate the
waste products.
 We call this ability of the environment to
absorb pollutants its absorptive capacity.
• If the emissions load exceeds the absorptive
capacity, then the pollutant accumulates in the
environment.
Classification of pollutants
i. By absorptive capacity
 Pollutants for which the environment has little
or no absorptive capacity are called stock
pollutants.
 Stock pollutants accumulate over time a
emissions enter the environment.
 Examples of stock pollutants include
 non biodegradable bottles tossed by the roadside;
heavy metals, such as lead, that accumulate in the
soils near the emissions source; and persistent
synthetic chemicals, such as dioxin and PCBs
(polychlorinated biphenyls).
Cont’d
 Pollutants for which the environment has some
absorptive capacity are called fund pollutants.
 For these pollutants, as long as the emissions rate
does not exceed the absorptive capacity of the
environment, the pollutants do not accumulate.
 Examples of fund pollutants are easy to find. Many
organic pollutants injected into an oxygen-rich
stream will be transformed by the resident bacteria
into less harmful inorganic matter.
 Carbon dioxide is absorbed by plant life and the
oceans.
Cont’d
II. by their zone of influence
• The horizontal dimension: deals with the
spatial domain over which damage from an
emitted pollutant is experienced.
• The damage caused by local pollutants is
experienced near the source of emission, while
the damage from regional pollutants is
experienced at greater distances from the
source of emission.
• The limiting case is a global pollutant, where
the damage affects the entire planet.
Cont’d
 The categories are not mutually exclusive; it is
possible for a pollutant to be in more than one
category. Sulfur oxides and nitrogen oxides, for
example, are both local and regional pollutants.
 The vertical zone: The vertical zone of influence
describes whether the damage is caused mainly by
ground-level concentrations of an air pollutant or by
concentrations in the upper atmosphere.
 For some pollutants, such as lead or particulates, the
damage caused by a pollutant is determined mainly by
concentrations of the pollutant near the earth’s
surface.
 Competitive Markets & Negative Externalities
 when firms can freely pollute, they produce and sell larger
quantity than when they are made to internalize externalities
 The difference in these two equilibrium prices indicates the
distortion of the price signal sent to consumers
– This creates an incentive for consumers to buy too much of the good
– Markets are not efficiently allocating scarce resources when there are
unresolved negative externalities
Cont’d
The social cost of an activity: the sum of the
private cost and the external cost
The difference is b/n MSC and MPC is MEC which brought by
market failures
$ per Unit
MSC
MPC

MEC

Quantity
 Efficient Allocation of Pollution

• Pollutants are the residuals of production and

consumption.
• These residuals must recycled or returned to the
environment in one form or another.
• Since presence of pollutants in the environment may
depreciate the environmental services, an efficient
allocation of resources must take this cost into account.
• Efficient level of pollution concept is used in
environmental economics to describe a situation in
which the marginal abatement cost (MACs) of a
polluter and the value of marginal damages (MDs) of
the pollution is equal.
Cont’d
 Figures below illustrates this concept: MAC is the
marginal abatement cost; MD is the marginal damages
and OE the efficient level of pollution.
 The efficient level of pollution is shown by the level E in
the diagram.
 This is the point at which the marginal abatement costs
and the marginal damage of the pollution are
equalized(MAC=MD).
 This is the efficient level b/c if pollution were to be abated
any further towards zero, the benefits (MD) would be out
weighed by the costs (MAC).
 This efficient outcome can be obtained through the use
of market based instruments (MBIs) or command and
control policies.
Cont’d
$
MAC MD

0 E Level of pollution

 MAC is the cost of abatement or controlling an extra unit of

pollution.
 It is also known as the marginal control cost
 MDC is the health or environment damage caused by an
extra unit of pollution.
 It is also known as the marginal pollution cost
Stock Pollutants
 The efficient allocation of a stock pollutant must
take into account the fact that the pollutant
accumulates in the environment over time and that
the damage caused by its presence increases and
persists as the pollutant accumulates.
 The damage caused by pollution can take many forms.
human health can be adversely impacted, possibly even
leading to death.
 Other living organisms, such as trees or fish, can be
harmed as well.
 Damage can even occur to inanimate objects, as when
acid rain causes sculptures to deteriorate or when
particulates cause structures to discolor.
Cont’d
 The optimal allocation of a stock pollutant
(The dynamic efficient allocation), by
definition, is the one that maximizes the
present value of the net benefit.
 In this case the net benefit at any point in time,
t, is equal to the benefit received from the
consumption of X minus the cost of the
damage caused by the presence of the stock
pollutant in the environment.
Cont’d
• This damage is a cost that society must bear,
and in terms of its effect on the efficient
allocation, this cost is not unlike that
associated with extracting minerals or fuels.
• While for minerals the extraction cost rises
with the cumulative amount of the depletable
resource extracted, damage arises as the
pollutant accumulates cost associated with a
stock pollutant rises with the cumulative
amount deposited in the environment
Cont’d
• The one major difference is that the extraction
cost is borne only at the time of extraction,
while damage persists as long as the stock
pollutant remains in the environment.
• Stock pollutants are, in a sense, the other side of
the intergenerational equity coin from
depletable resources.
• With depletable resources, it is possible for
current generations to create a burden for future
generations by using up resources, thereby
diminishing the remaining endowment
Cont’d
• Stock pollutants can create a burden for future
generations by passing on damages that persist
well after the benefits received from incurring
the damages have been forgotten.
• Though neither of these situations
automatically violates the weak sustainability
criterion, they clearly require further scrutiny.
Fund pollutants
• To the extent that the emission of fund
pollutants exceeds the assimilative capacity of
the environment, they accumulate and share
some of the characteristics of stock pollutants.
• When the emissions rate is low enough,
however, the discharges can be assimilated by
the environment, with the result that the link
between present emissions and future damage
may be broken.
Cont’d
 When this happens, current emissions cause current damage
and future emissions cause future damage, but the level of
future damage is independent of current emissions.
 This independence of allocations among time periods allows
us to explore the efficient allocation of fund pollutants using
the concept of static, rather than dynamic, efficiency.
 Because the static concept is simpler, this affords us the
opportunity to incorporate more dimensions of the problem
without unnecessarily complicating the analysis.
 Pollution control is most easily analyzed from the
perspective of minimizing cost.
– Damage costs
– Pollution control or avoidance costs
Cont’d
 Generally, the marginal damage caused by a
unit of pollution increases with the amount
emitted.
 When small amounts of the pollutant are
emitted, the incremental damage is quite small.
 However, when large amounts are emitted, the
marginal unit can cause significantly more
damage.
 Marginal control costs commonly increase
with the amount controlled or abated.
Cont’d
• In Figure 6.4 we use these two pieces of
information on the shapes of the relevant curves
to derive the efficient allocation.
• A movement from right to left refers to greater
control and less pollution emitted.
• The efficient allocation is represented by Q*, the
point at which the damage caused by the
marginal unit of pollution is exactly equal to the
marginal cost of avoiding it.(the cost minimizing
solution is founded by equating marginal
damaged costs to marginal control costs or at Q*
Cont’d

• Figure 6.4 efficient allocation of a fund pollutant

Market allocation of pollutant
• Damage costs are externalities
• Control costs are not externalities

• Therefore, what is cheapest for the firm is not always what is cheapest for society as a
whole.
• Firms that attempt to control pollution unilaterally are placed at a competitive
disadvantage
• The market fails to generate the efficient level of pollution control and penalizes firms
that attempt to control pollution
Environmental policy instruments
• Free market is usually unregulated to correct for the
damage done by their emissions.
• efficient outcome can be obtained through the use of :
 market-based instruments (MBIs) or
 command and control policies
• Market-based instruments
 modifies the market signals movement towards the
efficient level of pollution
 Examples :
• pollution charges,
• subsidies for pollution abatement,
Market-based instruments (MBIs)

• An approach to environmental policy which

modifies the market signals received by
producers and consumers in order to induce more
environmentally friendly behaviour or a
movement towards the efficient level of
pollution.
• Examples of MBIs are pollution charges,
subsidies for pollution abatement, marketable
permits, product charges, and full-cost resource
pricing.
• MBIs can be used to achieve the Pareto-efficient
level of emissions
Regulatory and Incentive-based Policies

• The techniques used by regulatory agencies, such as the

Environmental Protection Agency (EPA), to control
pollution range from charges for the right to pollute to
regulations that impose limits to the amount of a
pollutant. Among these are the following:
• Emission Charges:
• Emission Charges are prices established for the right to
emit a unit of a pollutant.
• Example: In the United Sates industrial polluters pay
effluent fees for the right to dump waste in municipal
water treatment plants
• Advantage: Directly internalizes a negative externality
by pricing the use of the environment to dispose of waste.
Emission Standards
 Limits established by government on the annual amounts
and kinds of pollutants that can be emitted into the air or
water by producers or users of certain products.
Example:
 EPA places limits on the number of grams/mile of
hydrocarbons, nitrogen dioxide and carbon monoxide
emitted per automobile. The automobile industry satisfies
these standards by equipping cars with catalytic
converters. In turn, this device raises the cost of cars.
Disadvantages:
- Allow emission of less than the standard free of charge
- Firms are restricted in the method of compliance
- Does not take into account differences among firms
- Does not take into account differences among regions
Command and Control Regulation
• A system or rule that requires the use of specific
pollution control devices on certain sources of pollution
or applies strict emission standards to specific emitters
• Example: All newly produced automobiles are required
to have catalytic converters to meet EPA emission
standards.
• Disadvantages:
- All emitters are treated equal
- Provides no incentive for emitters to seek less expensive
ways of reducing emission
- Provides no incentive to reduce emissions more than the
required amount
Pollution Rights

• A government issued permit allowing a firm to emit a specified

quantity of polluting waste.
• Example: Michigan's Air Emissions Trading Program
• Advantages:
 Pollution permits are tradable at free market prices
- Regulatory authorities can control the amount of pollution by
limiting the number of certificates
- Provides a choice: purchase permits and pollute or reduce
pollution and save the cost of permits
- Provides an incentive to reduce emissions in order to sell
previously purchased pollution rights
Disadvantage:
• A firm in a much polluted region is allowed to buy emission
permits from a firm in a region where there is no pollution.
 Failure of Government Intervention and alternatives

 Although there are good reasons for government to intervene,

they are often no better at managing natural resources than the
free market. Some of the reasons for this are:
 They may favor the interests of some part of the community rather
than the community as a whole. If government acts to please some
particular pressure group, it may not act to protect the
environment, especially if environmental protection would impose
costs on members of a particularly powerful pressure group.
 Governments are not very good at obtaining the right information
about the full consequences of a particular action. This is mostly
true because of the tendency of governments to compartmentalize
issues.
 They may have problems translating good intentions into practice
because of lack of competence among the government
bureaucracy
Cont’d
• An alternative to government intervention is proposed by Coase
(1960), who argues in favor of market bargaining underpinned by
appropriate property rights in order to achieve the social optimum of
pollution. Given the existence of an appropriate property rights
system (guaranteed ownership of resources via the force of law),
Coase argued that polluter and those affected by pollution should be
left to bargain in an unregulated situation.
• The Coase theorem states that regardless of who holds the property
rights, there is an automatic tendency to approach the social optimum
via bargaining.
• If this analysis is correct, then government regulation of externalities
is redundant, the market will take care of itself, with bargaining
representing an efficient process. Coase’s approach also has its
disadvantages and limitations.
• In reality, a combination of a property right system, regulations
and economic incentives may be the best approach to protect the
environment.