(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 698

CHAPTER 18 • Externalities and Public Goods 673 introduce fuel-efficient hybrid vehicles But prior to its hosting of the Olympics in 2008, Beijing had a problem What could it to reduce sulfur dioxide emissions so as to offer a cleaner environment to the Olympic athletes and to the visiting public? Beijing’s choice was to shut down a large number of coal-fired plants The air quality in Beijing improved 30 percent in 2008 for the Olympics, at a cost of about $10 billion But a year after the Games, when many of the environmental regulations were no longer in effect, about 60 percent of the improvement was lost Was the shutdown of plants the most efficient policy choice? Our study of pollutionabatement strategies suggests not For one thing, we have experience with the use of standards for regulating sulfur dioxide emissions in Philadelphia (recall Example 18.1) In 1968, Philadelphia imposed air-quality regulations that limited the maximum allowable sulfur content in fuel oil to 1.0 percent or less This regulation decreased sulfur dioxide levels in the air substantially—from 0.10 parts per million (ppm) in 1968 to below 0.030 ppm in 1973 EX AMPLE 18 Improved air quality led to better human health, less damage to materials, and higher property values Example 18.1 shows that the imposed standards made sense on cost-benefit grounds Would the imposition of a system of emissions fees—or better yet a regime of tradeable emissions permits—do even better in Beijing? A study of the regulation of electric-utility sulfur dioxide tradeable emissions shows that marketable permits in the United States can cut in half the cost of complying with a regulatory-based standard.7 Can similar gains be achieved in Beijing? The answer lies in part on whether the market for tradeable emissions will itself work efficiently But it also depends on the shape of the marginal abatement cost and marginal external cost curves As our prior discussion has shown, the case for emissions fees (and for tradeable permits) is strongest (1) when firms vary substantially in their marginal abatement costs; and (2) when the marginal external cost of emissions curve is relatively steep and the marginal cost of abatement curve relatively flat EMISSIONS TRADING AND CLEAN AIR Controlling emissions cost companies approximately $18 billion during the 1980s, and it cost even more during the first half of the 1990s.8 An effective emissions trading system could reduce those costs substantially in the decades to come The Environmental Protection Agency’s “bubble” and “offset” programs were modest attempts to use a trading system to lower cleanup costs A bubble allows an individual firm to adjust its pollution controls for individual sources of pollutants as long as a total pollutant limit for the firm is not exceeded In theory, a bubble could be used to set pollutant limits for many firms or for an entire geographic region; in practice, however, it has been applied to individual firms As a result “permits” are, in effect, traded within the firm: If one part of the firm can reduce its emissions, another part will be allowed to emit more Abatement cost savings associated with the EPA’s program of 42 bubbles have been approximately $300 million per year since 1979 Under the offset program, new sources of emissions may be located in geographic regions in which air-quality standards have not been met, but only if they offset their new emissions by reducing emissions from existing sources by at least as much Offsets can be obtained by internal trading, but external trading among firms is also allowed A total of more than 2000 offset transactions have occurred since 1976 Because of their limited natures, bubble and offset programs substantially understate the Don Fullerton, Shaun P McDermott, and Jonathan P Caulkins, “Sulfur Dioxide Compliance of a Regulated Utility,” NBER Working Paper No 5542, April 1996 See Robert W Hahn and Gordon L Hester, “The Market for Bads: EPA’s Experience with Emissions Trading,” Regulation (1987): 48–53; Brian J McKean, “Evolution of Marketable Permits: The U.S Experience with Sulfur-Dioxide Allowance Trading,” Environmental Protection Agency, December, 1996