Economics of Pollution Control

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

Pollutants for which the environment has little or no absorptive capacity are called stock pollutants

Pollutants for which the environment has some absorptive capacity are called fund pollutants

Defining the Efficient Allocation of Pollution

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 the presence of this pollutant in the environment is further assumed to

be proportional to the size of the accumulated stock. As long as the stock of pollutants remains in the

environment, the damage persists.

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. The efficient quantity of X (and therefore, the

addition to the accumulation of this pollutant in the environment) would decline over time as the marginal

cost of the damage rises. The price of X would rise over time, reflecting the rising social cost of production.

To cope with the increasing marginal damage, the amount of resources committed to controlling the

pollutant would increase over time. Ultimately, a steady state would be reached where additions to the

amount of the pollutant in the environment would cease and the size of the pollutant stock would stabilize.

At this point, all further emission of the pollutant created by the production of X would be controlled

(perhaps through recycling). The price of X and the quantity consumed would remain constant. The damage

caused by the stock pollutant would persist.

Fund Pollutants

The Marginal Abatement Cost Curve

Marginal control costs commonly increase with the amount controlled.

• Marginal abatement costs can be:

1. The costs of reducing pollution (e.g. costs of scrubbers, labor needed to maintain them,

etc.).

2. The opportunity costs of lowering consumption or production.

• The marginal abatement cost curve is downward sloping, and equals zero at the level of

unconstrained emissions.

o Firms choose the easiest ways to reduce pollution first.

o It may flatten if economies of scale are present.

• Things affecting the position of the MAC:

o Technology

• To add together the MAC of individual firms, we use a horizontal summation.

o Note that this follows from what Field calls the equimarginal principle – to minimize total

abatement costs, choose the lowest marginal abatement costs first, even if it means one firm

does more than the other.

Intuition: we do the simplest (the cheapest) abatement first.

The Marginal Damage Function

Generally, the marginal damage caused by a unit of pollution increases with the amount emitted.

• Our goal is to develop policies that lead to an optimal level of pollution.

o Recall that the optimal level of pollution is not zero.

o We need to consider the marginal costs and marginal benefits of pollution.

• The marginal damage function shows the damage done by an additional unit of pollution.

o It is upward-sloping.

o The slope normally gets steeper as emissions increase.

However, it may level off if there is a point where no more damage can be done

(e.g. all the pond life is dead).

o We can look at damage in one of two ways:

1. Emissions damage functions -- the marginal damage done by additional flows of

emissions.

2. Ambient damage functions -- the marginal damage done by additional

concentrations of pollution in the ambient environment.

o The area under the marginal damage function shows the total damages.

• The type of pollutant affects the shape:

o Flow pollutant – For a flow pollutant, the MDF does not change over time (if other things

remain equal).

o Stock pollutant – MDF is flat, and shifts up over time, because the stock keeps getting

larger

• Things that affect the position of the MDF include:

o Population

o Time of year

The Efficient Level of Pollution

• The optimal level of pollution is where the MDF and the MAC curves intersect. Here, the

additional benefits from pollution control are just equal to the additional costs.

o In these examples, the marginal benefits are the marginal damages avoided by increased

abatement.

o Note that this is not where total benefits equal total costs. If that were the case, net

benefits would be zero. Rather, we maximize net benefit by equating marginal benefits and

marginal costs.

o Some examples:

1. How would the desired level of pollution control change if a new technology is

discovered that improves the efficiency of scrubbers for power plants?

A new technology lowers the marginal abatement costs curve. Since

abatement is cheaper, we should do more of it. The efficient level of

pollution falls.

2. How does the desired level of pollution change between summer and winter if the

pollution leads to greater problems in the summer (e.g. ground level ozone)?

Here, the marginal damage function is higher in the summer than in the

winter. As a result, we want less pollution (e.g. more abatement) in the

summer.

The diagram suggests that under the conditions presented, the optimal level of pollution is not zero.

An alternative approach would be to internalize the marginal damage caused by each unit of emissions by

means of a tax or charge on each unit of emissions (see Example 14.1)

Cost-Effective Policies for Uniformly Mixed Fund Pollutants

The damage caused by these pollutants depends on the amount entering the atmosphere. In contrast to

nonuniformly mixed pollutants, the damage caused by uniformly mixed pollutants is relatively insensitive to

where the emissions are injected into the atmosphere. Thus, the policy can focus simply on controlling the

total amount of emissions in a manner that minimizes the cost of control.

Figure 14.3, is drawn by measuring the marginal cost of control for the first source from the left-hand axis

(MC1) and the marginal cost of control for the second source from the right-hand axis (MC2).

The cost of achieving a given reduction in emissions will be minimized if and only if the marginal costs of

control are equalized for all emitters.

Cost-Effective Pollution-Control Policies

Emissions Standards. In the economics literature this approach is referred to as the “command-and-control”

approach. An emissions standard is a legal limit on the amount of the pollutant an individual source is

allowed to emit.

• Government maximizes society's return to a public good when MB = MC

o If MB > MC, government should increase one more unit of a public good

o If MB < MC, government should decrease a public good by one unit

• Example: Government passes a tougher environmental law

o Benefits

Less pollution

People and the environment may be healthier from less pollution

o Cost

Firms are required to comply with law

Firms' costs are higher

• Cost-benefit analysis for public projects can be complicated. Easy to manipulate numbers.

Emissions Charges. An emissions charge is a fee, collected by the government, levied on each unit of

pollutant emitted into the air or water. The total payment any source would make to the government could

be found by multiplying the fee times the amount of pollution emitted.

Control authorities base the emissions standards on specific technologies. As new technologies are discovered

by the control authority, the standards are tightened. These stricter standards force firms to bear higher

costs. Therefore, with emissions standards, firms have an incentive to hide technological changes from the

control authority.

Cap-and-Trade. Under this system, all sources face a limit on their emissions and they are allocated (or sold)

allowances to emit. Each allowance authorizes a specific amount of emissions (commonly 1 ton). The control

authority issues exactly the number of allowances needed to produce the desired emissions level. These can

be distributed among the firms either by auctioning them off to the highest bidder or by granting them

directly to firms free of charge (an allocation referred to as “gifting”).

Cost-Effective Policies for Nonuniformly Mixed Surface Pollutants

For these pollutants, the policy must be concerned not only with the weight of emissions entering the

atmosphere, but also with the location and timing of emissions.

Ambient standards are legal ceilings placed on the concentration level of specified pollutants in the air, soil,

or water. They represent the target concentration levels that are not to be exceeded. A cost-effective policy

results in the lowest cost allocation of control responsibility consistent with ensuring that the predetermined

ambient standards are met at specified locations called receptor sites.

Since emissions are what can be controlled, but the concentrations at R are the policy target, our first task

must be to relate the two. This can be accomplished by using a transfer coefficient. A transfer coefficient (ai)

captures the constant amount the concentration at the receptor will rise if source i emits one more unit of

pollution.

We are now in a position to define the cost-effective allocation of responsibility. A numerical example

involving two sources is presented in Table 14.1. In this example, the two sources are assumed to have the

same marginal cost curves for cleaning up emissions. This assumption is reflected in the fact that the first two

corresponding columns of the table for each of the two sources are identical. The main difference between

the two sources is their location vis-à-vis the receptor. The first source is closer to the receptor, so it has a

larger transfer coefficient than the second (1.0 as opposed to 0.5). The objective is to meet a given

concentration target at minimum cost. Column 3 of the table translates emissions reductions into

concentration reductions for each source, while column 4 records the marginal cost of each unit of

concentration reduced. The former is merely the emissions reduction times the transfer coefficient, while the

latter is the marginal cost of the emissions reduction divided by the transfer coefficient (which translates the

marginal cost of emissions reduction into a marginal cost of concentration reduction).

The cost-effective allocation would be achieved when the marginal costs of concentration reduction (not

emissions reduction) are equalized for all sources. In Table 14.1, this occurs when the first source reduces six

units of emissions (and six units of concentration) and the second source reduces three units of emissions

(and 1.5 units of concentration).

Policy Approaches for Nonuniformly Mixed Pollutants: This framework can now be used to evaluate

various policy approaches that the control authority might use. We begin with the ambient charge, the

charge used to produce a cost-effective allocation of a nonuniformly mixed pollutant. This charge takes the

form:

where ti is the per-unit charge paid by the ith source on each unit emitted, ai is the ith source’s transfer

coefficient, and F is the marginal cost of a unit of concentration reduction, which is the same for all sources.

Because of trans-boundary aspect of pollution countries may enter into agreements with each other to fix

pollution problems

• Problems

o Free rider problem - Game theory is extensively used in trans-boundary pollution problems.

o Prisoner’s dilemma

o Two countries: United States and Canada

o If both countries choose tough environmental laws, their GDPs grow at 1%

o If one country has soft environmental laws and the other has tough, then industries with the

weak laws have a cost advantage.

They can produce more output, increasing GDP they grow at 6%

o If both countries have soft environmental laws, then their GDPs growth at 5%

• United States choice is to choose between tough or soft environmental laws.

o The dominant strategy is to choose the soft environmental laws, given Canada has a choice.

The reason is GDP is larger

• Canada’s choice is to choose between tough or soft environmental laws.

o The dominant strategy is to choose the soft environmental laws, given the United States has

a choice.

The reason is GDP is larger

• We should be at Cell A, but we always end up at Cell D

Civic duty

Civic duty - people and firms may voluntarily reduce their pollution

• Why do firms voluntarily reduce their pollution? Implicit client pressure

• Examples

o General Electric's commitment to reduce CO2 emissions

GE's CEO thinks this will be profitable.

GE hopes to be a technology leader if regulations are put in place.

o British Petroleum (BP) is investing in green technologies

Solar panels at gas stations

• United States and Europe have a strong movement for “Being Green”

o Allows firms to differentiate products

Some consumers are willing to pay a premium for ‘green’ products.

Examples: Organic foods - uses no chemicals like pesticides and fertilizers

o Preempting tougher regulation

Industry tries to act first before government passes tougher environmental laws

o Investor pressure

“Green” investors may prefer socially responsible firms

All investors may be concerned about liability from environmental pollution

Example:

Chemical Manufacturers Association started 'Responsible Care Program'

Started because of the 1984 Union Carbide storage tank leak in Bhopal,

India.

42 tonnes of toxic methyl isocyanate (MIC) gas were released

Approximately 8,000 -10,000 died within 72 hours

25,000 have since died from gas-related diseases.

The Montreal Protocol

• Example of a successful international agreement.

o Signed in 1987 by members of the United Nations to phase out substances that are harmful

to the earth's ozone layer

o Since the 1970s scientists have documented the depletion of the ozone by

chlorofluorocarbons (CFCs), commonly used for refrigeration and as solvents and aerosol

propellants

o Phase-out the use, production, and exports of chlorofluorocarbons (CFCs)

Used as a coolant in refrigerators and air conditioners

• CFCs destroy the ozone layer in upper atmosphere

o Contains chlorine that destroys the ozone by turning it back into 2O

o Publicity surrounding the ozone hole over Antarctica provided public pressure.

• An amendment of the Montreal Protocol was made in 1990 by 93 nations, including China and

India, who had not previously participated, to eliminate the use of CFCs, carbon tetrachloride, and

halon gases by the year 2000 and eliminate the production of methyl chloroform by 2005

o This 1990 amendment also established the “Montreal Protocol Multilateral Fund” to help

developing countries become less dependent on ozone-depleting chemicals. A $260 million

fund was established to help finance the transition to HCFC

o Wanted to reduce leakages - countries that did not sign would start producing CFCs

• In November 1992 delegates from all over the world met again in Copenhagen, Denmark, to further

revise the Montreal Protocol and accelerate the phase-out of ozone-damaging substances and regulate

three additional chemicals

o Some of those provisions were as follows: phase out production of CFCs and carbon

tetrachloride by 1996

o Ban halons by 1994 (the production of halogen was ended in 1994 in most industrialized

nations and is expected to be halted in China, Korea, India, and the former Soviet Union

by 2010)

o End production of methyl chloroform by 1996

o Control the use of hydrochloroflurocarbons (HCFCs)

o Eliminate them by 2030; and increase funding for the Multilateral Fund (between $340 and

$500 million by 1996).

• Since the Copenhagen Amendments there have been other amendments, such as the Montreal

Amendment of 1997, which adjusted the timetable for phase out of some substances and modified

trade restrictions, including the creation of a licensing system to attempt to decrease the black

market in ozone depleting substances

• Beijing Amendment in 2002, which closely monitors bromochloromethane and the trade of

hydrochloroflurocarbons

• As of July 2002, 175 nations have ratified the Montreal Protocol. However, while countries have

volunteered to control ozone-damaging chemicals, individual companies can still produce the

banned chemicals for “essential uses and for servicing certain existing equipment”

• Why the Montreal Protocol was successful?

o Most international agreements are not successful

Leakages

Cheating

o Only six main companies produce CFCs, so monitoring simple.

o Clean technological substitutes have developed quickly.

This helped keep the costs of compliance low.

One substitute, hydrochlorofluorocarbons (HCFC) also depletes the ozone layer,

but at a slower rate.

It will be phased out by 2030

o Note - both CFCs and HCFCs are greenhouse gases

• The United States passed a tax on CFCs

o Producers paid $1.37 per pound for CFCs in 1990

$5.35 per pound in 1995

Kyoto Protocol

In December 1997, representatives of 160 nations met in Kyoto, Japan, in an attempt to produce a new and

improved treaty on climate change. Major differences occurred between industrialized and still developing

countries with the United States perceived, particularly by representatives of the European Union (EU), as

not doing its share to reduce emissions, especially those of carbon dioxide.

The Kyoto Protocol was adopted in Kyoto, Japan on the 11th of December, 1997, but not enacted or

enforced until the 16th of February, 2005. The protocol was adopted to help combat the adverse effects of

climate change, or global warming. The UNFCCC (United Nations Framework Convention on Climate

Change), an international environmental treaty, states the goal of the Kyoto Protocol as the “stabilization of

greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic

interference with the climate system.”

The Kyoto Protocol's main goal is to reduce the presence of 4 harmful greenhouse gases (GHG's):

1. Carbon Dioxide

2. Methane

3. Nitrous Oxide

4. Sulphur Hexafluoride

These gases belong into two groups, both of which are being targeted by the protocol:

1. Hydrofluorocarbons

2. Perfluorocarbons

The goal is to reduce emissions by 5.2%, compared to 1990 levels. That doesn't sound unreasonable to us,

especially considering that shipping and international aviation emissions are not included in that percentage.

The requirements would be different for each country and would have to begin by 2008 and be met by 2012.

Since its inception, the Kyoto Protocol has generated a great deal of controversy. Richer nations have argued

that the poorer, less developed nations are getting off easy. The developing nations, on the other hand, have

argued that they will never be able to catch up with the richer nations unless they are allowed to develop

with the same degree of pollution as that which let the industrial nations become rich in the first place.