Chapter Economic Solutions to Environmental Problems: The Market Approach © 2004 Thomson Learning/South-Western Descriptive Overview Market approach – an incentive-based policy that encourages conservative practices or pollution reduction strategies Difference between market approach and commandand-control approach is how each approach attempts to achieve its objectives Descriptive Overview Identifying Types of Market Instruments Pollution charge Subsidies Deposit/refund systems Pollution permit trading systems Pollution Charges Pollution charge – a fee that varies with the amount of pollutants released “Polluter-pays principle” Product charge – a fee added to the price of a pollution-generating product based on its quantity or some attribute responsible for pollution Pollution Charges Modeling a Product Charge as a Per Unit Tax Policy motivation of a product charge is to induce firms to internalize the externality by taking account of the MEC in their production decisions Pigouvian tax – a unit charge on a good whose production generates a negative externality such that the charge equals the MEC at Q Assessing the Model Difficult to identify the dollar value of MEC at Q Model implicitly allows only for an output reduction to abate pollution E E Pollution Charges Figure 5.1 Implementation of a Pigouvian Tax to Achieve Efficiency Pollution Charges Modeling an Emission Charge: Single-Polluter Case Emission or effluent charge – a fee imposed directly on the actual discharge of pollution Assessing the Model Emission charge stimulates the natural economic incentives of the polluter Pollution Charges Figure 5.2 Modeling an Emission Charge for a Single Firm Pollution Charges Figure 5.3 Effect of Technology Improvement on a Firm’s Least-Cost Decision Making Pollution Charges Modeling an Emission Charge: Multi-Polluter Case Assessing the Model Emission charge exploits each polluter’s natural incentive to pursue a least-cost strategy Low-cost abaters most of the cleaning up and highcost abaters pay more in taxes to cover the greater damages they cost Potential increase in monitoring costs Part of tax burden is shared with consumers in form of higher prices 10 Pollution Charges Pollution Charges In Practice Internationally, pollution charge is most commonly used market-based instrument Several countries use effluent charges to control the noise pollution generated by aircraft Real-world application of the product charge is one levied on lubricant oils by Finland, Hungary, and Italy 12 Environmental Subsidies Two major types of subsidies: Abatement equipment subsidies Pollution reduction subsidies 13 Environmental Subsidies Modeling an Abatement Equipment Subsidy Abatement equipment subsidy – a payment aimed at lowering the cost of abatement technology Attempts to internalize the positive externality associated with the consumption of abatement activities Pigouvian subsidy – a per unit payment on a good whose consumption generates a positive externality such that the payment equals the MEB at Q Assessing the model E Difficulty measuring the MEB May bias polluters’ decisions about how best to abate 14 Environmental Subsidies Modeling a Per Unit Subsidy on Pollution Reduction Per unit subsidy on pollution reduction – a payment for every unit of pollution removed below some predetermined level Assessing the Model Might be less disruptive than an equipment subsidy Can have perverse effect of elevating pollution levels in the aggregate 15 Environmental Subsidies Environmental Subsidies in Practice Internationally, many countries offer environmental subsidies in the form of grants or low-interest loans In the United States, the most common use is federal funding for publicly owned treatment works 16 Deposit/Refund Systems Deposit/refund system – a market instrument that imposes an up-front charge to pay for potential damages and refunds it for returning a product for proper disposal or recycling Combines the incentive characteristic of a pollution charge with a built-in mechanism for controlling monitoring costs 17 Deposit/Refund Systems Economics of Deposit/refund Systems Intended to force the potential polluter to account for both the marginal private cost (MPC) and the marginal external cost (MEC) of improper waste disposal Targets the potential polluter instead of penalizing the actual polluter 18 Deposit/Refund Systems Modeling a Deposit/Refund System Deposit serves the same function as a pollution charge with the critical difference that the refund helps to deter improper waste disposal Assessing the Model Encourages environmentally responsible behavior without adding to monitoring and compliance costs Can be used to encourage more efficient use of raw materials 19 Deposit/Refund Systems Figure 5.5 A Pigouvian Subsidy in the Market for Scrubbers 20 Deposit/Refund Systems Deposit/Refund Systems in Practice Beverage container disposal Disposal of used tire, car hulks, and lead-acid batteries 21 Deposit/Refund Systems Figure 5.6 Modeling a Deposit/Refund System in the Market for Waste Disposal 22 Pollution Permit Trading Systems Pollution permit trading system – a market instrument that establishes a market for rights to pollute by issuing tradeable pollution credits or allowances Pollution credits – tradeable permits issued for emitting below an established standard Pollution allowances – tradeable permits that indicate the maximum level of pollution that may be released 23 Pollution Permit Trading Systems Structure of a Pollution Trading Systems Two components: The issuance of some fixed number of permits in a region A provision for trading these permits among polluting sources within that region Bargaining gives rise to a market for pollution rights 24 Pollution Permit Trading Systems Modeling a Pollution Permit System for Multiple Polluters Incentive to trade as long as two firms face different MAC levels Trading will continue until the incentive to so no longer exists, at which point, the cost-effective solution is obtained Assessing the Model Trading establishes the price of a right to pollute without intervention No tax revenues are generated Trading system is more flexible 25 Pollution Permit Trading Systems Pollution Trading Systems in Practice Still in early stages of development Few international examples In the United States, Clean Air Act Amendments of 1990 establish an allowance-based trading program to control sulfur dioxide emissions 26 [...]... lowering the cost of abatement technology Attempts to internalize the positive externality associated with the consumption of abatement activities Pigouvian subsidy – a per unit payment on a good whose consumption generates a positive externality such that the payment equals the MEB at Q Assessing the model E Difficulty measuring the MEB May bias polluters’ decisions about how best to abate 14 Environmental. .. a market instrument that imposes an up-front charge to pay for potential damages and refunds it for returning a product for proper disposal or recycling Combines the incentive characteristic of a pollution charge with a built-in mechanism for controlling monitoring costs 17 Deposit/Refund Systems Economics of Deposit/refund Systems Intended to force the potential polluter to account for both the. .. cost (MPC) and the marginal external cost (MEC) of improper waste disposal Targets the potential polluter instead of penalizing the actual polluter 18 Deposit/Refund Systems Modeling a Deposit/Refund System Deposit serves the same function as a pollution charge with the critical difference that the refund helps to deter improper waste disposal Assessing the Model Encourages environmentally... some predetermined level Assessing the Model Might be less disruptive than an equipment subsidy Can have perverse effect of elevating pollution levels in the aggregate 15 Environmental Subsidies Environmental Subsidies in Practice Internationally, many countries offer environmental subsidies in the form of grants or low-interest loans In the United States, the most common use is federal funding... charge is most commonly used market- based instrument Several countries use effluent charges to control the noise pollution generated by aircraft Real-world application of the product charge is one levied on lubricant oils by Finland, Hungary, and Italy 12 Environmental Subsidies Two major types of subsidies: Abatement equipment subsidies Pollution reduction subsidies 13 Environmental Subsidies... Deposit/Refund System in the Market for Waste Disposal 22 Pollution Permit Trading Systems Pollution permit trading system – a market instrument that establishes a market for rights to pollute by issuing tradeable pollution credits or allowances Pollution credits – tradeable permits issued for emitting below an established standard Pollution allowances – tradeable permits that indicate the maximum level... components: The issuance of some fixed number of permits in a region A provision for trading these permits among polluting sources within that region Bargaining gives rise to a market for pollution rights 24 Pollution Permit Trading Systems Modeling a Pollution Permit System for Multiple Polluters Incentive to trade as long as two firms face different MAC levels Trading will continue until the incentive... incentive to do so no longer exists, at which point, the cost-effective solution is obtained Assessing the Model Trading establishes the price of a right to pollute without intervention No tax revenues are generated Trading system is more flexible 25 Pollution Permit Trading Systems Pollution Trading Systems in Practice Still in early stages of development Few international examples In the. .. to deter improper waste disposal Assessing the Model Encourages environmentally responsible behavior without adding to monitoring and compliance costs Can be used to encourage more efficient use of raw materials 19 Deposit/Refund Systems Figure 5.5 A Pigouvian Subsidy in the Market for Scrubbers 20 Deposit/Refund Systems Deposit/Refund Systems in Practice Beverage container disposal Disposal... Pollution Trading Systems in Practice Still in early stages of development Few international examples In the United States, Clean Air Act Amendments of 1990 establish an allowance-based trading program to control sulfur dioxide emissions 26