Pigouvian fees Making Prices Work for the Environment

Chapter Pigouvian Fees Making Prices Work for the Environment The Welfare Economic Point of Prices • Market prices should reflect marginal cost of production and marginal willingness to pay • If market prices not reflect this, can we change the prices? • Yes we can (at least in principle) The Porrige Model with many damage to several individuals • x is pollution from a firm • Damage = D(x) = ∑iDi(x) • Cost of pollution reduction C(x) • Optimal x* minimize (D(x) + C(x)) • First order condition D’(x) = ∑iD’i(x) = C’(x) • Market outcome if there are no property rights C’(xM) = Pigouvian Fee – The Tax Case • Regulator choses an emission tax T • Firms maximise – C(x) – Tx • Foc: C’(x)=–T • If –T = D’(x*) = ∑iD’i(x*) Then optimal x is achieved in a market economy • Firm pays Tx* in total taxes Pigouvian Fee – The Subsidy Case • Regulator selects a subsidy S • Firms maximise S(xM–x) – C(x) • Foc: C’(x)=–S • If –S = D’(x*) = ∑iD’i(x*) Then optimal x is achieved in a market economy • Firm Receive S(xM–x*) in total subsidies Insights: • Efficiency can be achieved both through pollution taxes and pollution reduction subsidies • Again there are distributional issues involved • The choice of whether to choose taxes or subsidies depend on: – How we feel about distribution – What does the most damage to the rest of the economy – A tax reduces the need for taxation in the rest of the economy (Good) – A subsidy requires a tax somewhere else (bad) But wait – There is more to this • Briefly – The choice between taxes ond subsidies also affect entry/exit decisions in the market • A subsidy may lead to firms staying in the market that really should be allowed to go bust Imperfect competition and Pigouvian fees • With imperfect competition a badly set fee may make things worse • If a tax is set at marginal damage, then the monopolist makes the consumers carry some of the taxation burden and reduce output ”too much.” Chapter Regulation Assessing regulatory regimes Different approaches to Pollution Control • Command and Control The government directly fixes: – Outputs – Pollution quotas – Technology choice • Market oriented approach The government sets incentives by affecting prices Pros and Cons of different Approaches • Command and Control introduces weak incentives for altering behaviour • Market incentives are decentralised Firms can choose innovative ways of achieving their aims • The economics of information makes the choice of regime hard Weitzman Prices vs Quantities) Chapter Fees and Permits Complications Spatial Issues • How to model efficiency when the damage is emission location specific? • A physical model of emission transportation is required • For instance if there are n polluters and m areas affected, and the fraction of pollution from i that ends up in j is aij, then we must specify this e.g by y = Ax where A is a m×n matrix with elements aij Example – Acid Rain • Min ∑iCi(xi) subject to Ax = y y* • Gives rise to FOC: Ci’(xi) = ∑ji aij • The optimal marginal cost is therefore location specific Emission trading – a market based approach • n polluters pollute x=∑xi • Decouples efficiency and welfare maximisation – How to choose x – Given x, how to choose xi • Two different questions The first is hard, but emission trading makes the second easy Emission trading • Efficient allocation of xi requires that C’i = Constant acorss different polluters • If firms can trade emission quotas at a price q, then marginal costs are equalised C’i = q for all i • But this requires that there are no spatial problems See brilliant article Førsund and Nævdal(1998) to see how emission trading can be done in a spatial context [...]... Approaches • Command and Control introduces weak incentives for altering behaviour • Market incentives are decentralised Firms can choose innovative ways of achieving their aims • The economics of information makes the choice of regime hard Weitzman Prices vs Quantities) Chapter 9 Fees and Permits Complications Spatial Issues • How to model efficiency when the damage is emission location specific? • A physical... emission transportation is required • For instance if there are n polluters and m areas affected, and the fraction of pollution from i that ends up in j is aij, then we must specify this e.g by y = Ax where A is a m×n matrix with elements aij Example – Acid Rain • Min ∑iCi(xi) subject to Ax = y y* • Gives rise to FOC: Ci’(xi) = ∑ji aij • The optimal marginal cost is therefore location specific Emission... – Given x, how to choose xi • Two different questions The first is hard, but emission trading makes the second easy Emission trading • Efficient allocation of xi requires that C’i = Constant acorss different polluters • If firms can trade emission quotas at a price q, then marginal costs are equalised C’i = q for all i • But this requires that there are no spatial problems See brilliant article Førsund