Transcript Regulatory Options & Efficiency

Regulatory Options &
Efficiency
What guidance can economics
provide about how to regulate
polluting industries or firms?
Why regulate?
Does free market efficiently provide
goods and services?
Market failure (externalities, public
goods, etc.)
Market power (monopolies inefficiently
restrict production to raise prices)
Information problems (damages
uncertain, food safety, env quality)
Types of questions in regulation
1. What is the “optimal” amount of
pollution?
2. To reduce by X%, who should reduce
and by how much?
3. What regulatory instrument(s) should
be used to achieve that level?
The efficient amount of pollution
$/unit
Marginal
Control
Cost
Total
Damage
Cost
Marginal
Damage
Cost
Total Control
Cost
Q*
Units of pollution
Recall example from 1st day
60 firms, each pollute 100 tons
30 low abatement cost ($100/ton)
30 high abatement ($1000/ton)
Everyone reduces 1 ton: Cost=$33,000
Total reduction = 60 tons.
For same cost could have reduced 330
tons.
If low cost firms abate:
Either:
• Reduce more pollution for the same
amount of money…or
• Reduce the same amount of pollution
for less money.
So we always want low-cost firm to
abate.
If costs aren’t constant: greenhouse
emissions of Nitrogen
Cost
($)
MCA
Who should abate
the 1st unit of N?
MCB
N
How much abatement from each?
$ (A)
Loss from equal
reduction
MCA
$ (B)
MCB
A: 0
B: 80
25
55
40
40
80
0
How did he do that?
1. Determine how much total abatement
you want (e.g. 80)
2. Draw axis from 0 to 80 (A), 80 to 0 (B)
3. Sum of abatements always equals 80.
4. Draw MCA as usual, flip MCB
5. Lines cross at equilibrium
6. Price is MC for A and for B.
The “equimarginal principle”
Not an accident that the marginal
abatement costs are equal at the most
efficient point.
Equimarginal Principle: Efficiency for a
homogeneous pollutant requires
equating the marginal costs of control
across all sources.
Control costs
Should include all other costs of control
monitoring & enforcement
administrative
Equipment
High cost firms have incentive to
innovate and change production
technology
Regulatory uncertainty increases costs.
Instruments for regulation
Taxes: charge $X per unit emitted. This
increases the cost of production.
Forces firms to internalize externality.
Quotas/standards: uniform standard (all
firms can emit Y) or non-uniform.
Tradable permits: All firms get Y permits
to pollute, can buy & sell on market.
Other initial dist’n mechanisms.
Example 1: Taxes in China
China: extremely high air pollution –
causes significant health damage.
Instituted wide-ranging system of
environmental taxation
2 tiers
World Bank report estimates that MC of
abatement << MB of abatement.
A creative quota: bubble policy
Multiple emissions sources in different
locations.
Contained in an imaginary “bubble”.
Regulation only governs amount that
leaves the bubble.
May apply to emissions points within
same plant or emissions points in plants
owned by other firms.
Example 2: Bubble policy in RI
Narraganset Electric Company:
2 generation facilities in Providence, RI.
Required to use < 2.2% sulfur in oil.
Under bubble policy:
Used 2.2% in one plant, burned natural
gas at other plant
Savings:
$3 million/year
$/unit
MSC
MPC
P*
MEC
Pp
D
Q*
Qc
Dirty Good
What tax or quota is required?
We know:
Optimal level of pollution is Q*
Marginal Social Cost at the optimum is P*
Marginal Private Cost at optimum is Pp.
Optimal tax exactly internalizes
externality:
t* = P* - Pp
Effectively raises MC of production
$/unit
MPC
(with tax)
MSC
t*
P*
MPC
(no tax)
Pp
D
Q*
Qc
Q (pollution)
Taxing consumption instead
Taxing consumption:
Taxing consumers for every unit of a
polluting good that is purchased.
E.g. Automobile gasoline
Can equivalently be used:
Instead of raising production costs, a
consumption tax lowers demand.
$/unit
MSC
MPC
(no tax)
P*
Pp
t*
D (no tax)
D (with tax)
Q*
Qc
Q (pollution)