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