Transcript Chapter 9

The Economic Approach to
Environmental and Natural
Resources, 3e
By James R. Kahn
© 2005 South-Western, part of the Thomson Corporation
Part II
Exhaustible Resources, Pollution and
the Environment
Chapter 9
The Use of Energy and the
Environment
© 2004 Thomson Learning/South-Western
Introduction
 The focus of this chapter is on the impact of energy
use on the environment, with a particular focus on
air pollution and acid rain.
 Although all types of energy have some type of
environmental impact, fossil fuels are responsible
for the majority of the negative impacts of energy
use. This is due to:
the large environmental impact per BTU of fossil fuel
use, and
the magnitude of fossil fuel production and use.
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Introduction
 Perhaps the greatest negative interaction between
energy and the environment occurs with air
pollution, where the combustion of fossil fuels is
the major source of the air pollutants that were
initially regulated by the 1972 Clean Air Act, with
amendments in 1977 and 1990.
 These pollutants include particulates, sulfur oxides
(SOx), nitrogen oxides (NOx), carbon monoxide
(CO), volatile organic compounds (VOCs), and lead
(Pb).
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http://www.epa.gov/airtrends/
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Introduction
 As Figure 9.1 indicates, the level of most of these pollutants
have declined since the passage of the Clean Air Act, except
for nitrogen oxides.
 Nitrogen oxides have increased because of the increasing
emissions from on-road and off-road vehicles and off-road
engines.
 In addition to fuel consumption, the use of energy is
responsible for virtually all the pollutants in the
transportation sector and a good portion of the emissions in
industrial processes.
 Despite reductions in overall emission levels in the US,
approximately 98 million people live in “nonattainment
areas” (locations which persistently fail to meet national
ambient air quality standards).
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Regulations on Stationary Sources of Pollution
 Stationary sources of criteria air pollutants (smokestacks
from factories and buildings) are regulated under the Clean
Air Act of 1972 and its amendments (1977 and 1990).
 Using federal government established national ambient
standards on concentration of each pollutant, states
implemented command and control policies to reduce
emissions.
 These command and control policies did not allow firms to
seek cost-minimizing alternatives in production.
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Regulations on Stationary Sources of Pollution
 The “Pollution Bubble” concept was a modification
of the command and control regulations which
treated each firm as if a glass bubble encased the
entire firm's operations.
 Firms could make adjustments within the bubble as
long as the pollution that left the bubble conformed
to emissions limitations.
 While allowing some flexibility to respond to
pollution standards, even the modified policy was
not effective in reducing pollution.
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Regulations on Stationary Sources of Pollution
 An interesting case in point is Southern California
which, primarily because of automobile traffic,
could not meet the federal standards.
 Southern California was declared a non-attainment
zone, and no new sources of pollution were
permitted.
 This meant no growth in industry and the
possibility of a stagnant economy.
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Regulations on Stationary Sources of Pollution
 Modification to the Clean Air Act allowed new
emission sources if they induced existing polluters
to reduce pollution by 150 percent of the amount
generated by the new source.
 This "offset" system allowed development but
limited trade to new firms and was not as efficient
a policy as marketable permits.
 As part of its effort to meet ambient quality
standards, California currently has the most
stringent standards on emissions from automobiles
in the nation.
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Stationary Source of Pollution and Acid Rain
 Acid deposition refers to a process by which certain types of
pollutants chemically transform into acidic substances in the
atmosphere and then fall to the earth.
 Forms of precipitation include acid rain, acid snow, and acid
fog.
 It also possible to have dry deposition.
 While acid rain has received a lot of press, there is
considerable uncertainty about the actual damages
generated by the emissions of acid deposition precursors.
 Precursor pollutants are those pollutants that are chemically
transformed to generate the substances that actually cause
the environmental damage.
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Stationary Source of Pollution and Acid Rain
 The Acid Precipitation Act of 1980 was the
culmination of concerns about acid deposition
which began in the 1970s.
 This act established the National Acid Precipitation
Assessment Program (NAPAP) to provide regional
information about effects of acidity on resources,
the extent to which acid deposition and related
pollutions are responsible for causing these
impacts, and strategies to control acid deposition
and related pollutants.
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Stationary Source of Pollution and Acid Rain
 Acid rain belongs to a category of pollutants referred to as
regional pollutants, which have effects over more than just
the vicinity of their emission.
 Unlike global pollutants, location of emissions is important
with regional pollutants.
 Acid deposition problems often manifest as transboundary
(transfrontier) pollutants.
 Two examples include:
 Sulfur dioxide emissions in the United States which affect
environmental quality in Canada and vice versa.
 Pollution generated in Great Britain and Germany which causes
acid deposition in Scandinavia.
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What Causes Acid Deposition?
 The most important precursor pollutants in the acid deposition problem
are sulfur dioxide and nitrous oxides.
 Sulfur dioxide is associated with the burning of coal and oil as boiler
fuel.
 Coal in particular often contains toxic heavy elements such as lead, and
often contains sulphur.
 Emissions can be minimized through the use of (more expensive)
cleaner coal – e.g., anthracite in preference to lignite and bitumenous.
 Many toxic components of petroleum can be removed as part of the
refining process.
 Nitrous oxides are primarily associated with automobile emissions.
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What Causes Acid Deposition?
 Acid rain and other forms of acid deposition are caused
when sulfur dioxide and nitrous oxides form sulfate and
nitrate in the atmosphere, which then combines with
hydrogen ions to form acids.
 Sulfate and nitrate molecules are formed when sulfur
dioxide and nitrous oxides combine with oxidants in the
atmosphere.
 Precipitation contains traces of sulphuric (H2SO4) and nitric
(HNO3) acids.
 Concentration determines pH, which is less than 7 for acids,
and should be less than approximately 5.00 for acid rain.
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What Causes Acid Deposition?
 Tropospheric ozone (03) is an important oxidant which is
formed when two pollutants, nitrous oxide and volatile
organic compounds (VOCs) chemically interact in the
presence of sunlight.
 The presence of VOCs in the atmosphere, while not directly
responsible for acid deposition, leads to greater proportions
of sulfur dioxide being converted to sulfate and nitrous
oxides being converted to nitrate.
 The following tables provide various anthropogenic sources
of sulfur dioxide, nitrogen oxides, and VOCs emissions and
trends in emission levels (a complete list is in the
Appendix).
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What Causes Acid Deposition?
 The nature of the chemical relationships requires a
coordinated effort at reduction of the differing pollutants.
 A reduction in nitrous oxides not only directly reduces acid
rain, but indirectly reduces the conversion of sulfur dioxide
by reducing ozone.
 The interactions among these pollutants make the
identification of the optimal level of pollution an extremely
difficult problem.
 The marginal damage function for sulfur dioxide depends
not only on itself but also on the level of nitrous oxide and
VOCs.
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What Causes Acid Deposition?
 Even if the marginal abatement cost function was known, one could not
determine the optimal level of sulfur dioxide emissions without also
knowing the costs of reducing nitrous oxide and VOCs, which in turn
could shift the marginal damage function.
 The process of identifying the optimal level of sulfur dioxide (or nitrous
oxide or VOCs) can be even more complex if the marginal abatement
cost of one pollutant is a function of the abatement level of other
pollutants.
 Changes in a production process that increase energy efficiency could
reduce the level of all pollutants, while some abatement devices,
scrubbers for example, result in a decrease in one type of pollutant and
an increase in another.
 As Figure 9.3 indicates the optimal level of a pollutant becomes a
moving target.
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What Causes Acid Deposition?
 Since the optimal level of each of the three pollutants cannot be
determined independently of each other, the level of emissions of each
must be chosen to minimize the sum of the total abatement costs and
total damages associated with all three pollutants.
 Equation 9.1 represents the situation where total abatement costs (TAC)
are a function of the level of emissions of all three pollutants (El,E2,E3).
 Equation 9.2 represents total damages (TD) as a function of all three
pollutants.
 The minimization of the sum of total abatement costs and total
damages requires that the marginal damages of each pollutant are
equal to the marginal abatement costs of each pollutant.
 Equations 9.3 – 9.5 must be solved simultaneously to determine the
optimal output level of each pollutant.
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The Impacts of Acid Deposition
 Acid deposition and related pollutants have many significant impacts on
natural systems and human systems.
 These include acidification of surface water and detrimental effects on
high elevation coniferous forests.
 Sulfur dioxide, sulfate particles, and acid aerosols are all suspected of
having detrimental effects on human health, e.g., greater incidence of
asthma.
 Ozone, caused by the emission of nitrous oxides, has harmful effects on
both vegetation and humans.
 The particles that generate acid deposition also serve to scatter light,
creating a "pollution haze," reducing visibility, and amplifying climate
change.
 Acid deposition also leads to the premature weathering and
degradation of materials used in buildings, monuments, fences, and
other structures.
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The Impacts of Acid Deposition
 Table 9.1 illustrates the effects associated with acid
precipitation, as presented in the 1990 Integrated
Assessment Report of NAPAP.
 Market effects indicated impacts that are felt by
producers and consumers of goods that are bought
and sold.
 Nonmarket values can be either use or non-use
values.
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Acid Deposition Policy
 Although research conducted to determine acid deposition relationships
yielded important insights into cause and effect relationships, the
knowledge was site specific and not easily generalized to larger
regions.
 The NAPAP research program, which spanned the decade of the 1980s,
resolved many scientific questions concerning the dispersion of
pollutants, the chemistry of its transformation into acid deposition, and
many of the ecological effects of the acid deposition.
 Very little research money was spent looking at the willingness to pay
to prevent identified impacts based on the belief that the uncertainty
involving the scientific relationships would result in meaningless
estimates of economic relationships.
 How do policymakers develop a set of efficient policies when the
benefits of reducing acid deposition are unquantifiable?
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Pre-1990 Acid Deposition Policy
 The pre-1990 Acid Deposition Policy focused primarily on the
establishment of cause and effect relationships.
 The Reagan administration's policy required that more information be
developed before implementing any reductions in emissions of SO2 and
NOx.
 SO2 and NOx are "criteria pollutants” that are regulated under the 1972
Clean Air Act and the 1977 Clean Air Act Amendments.
 The fact that these regulations focus on local effects of emissions may
have exacerbated the problem.
 One way in which a local polluter can minimize the local effect of
pollution emissions is to build a tall smoke-stack which injects
pollutants into higher wind currents which carry these pollutants into
other areas.
 These tall smokestacks were, to a large extent, responsible for the sulfur
component of the acid deposition problem.
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Acid Deposition Policy and the 1990 Clean Air Act
 The political problem associated with supporting legislation which
reduces the standard of living of constituents was dealt with through
the creation of the 1990 Clean Air Act Amendments (CAAA), which
packaged several environmental problems within the same pieces of
legislation.
 These amendments address the problems of acid rain, local air quality
associated with ozone and carbon monoxide, pollution from cars and
trucks, air toxins, and stratospheric and global climate protection.
 Acid deposition is dealt with in Title IV of the 1990 CAAA, which
specifies a ten million ton reduction in annual sulfur dioxide emissions
to be achieved by the year 2000.
 An interesting aspect of Title IV of the 1990 CAAA is that it represents
the first attempt by the federal government to implement a system of
marketable pollution permits.
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Acid Deposition Policy and the 1990 Clean Air Act
 Economists applauded the incorporation of marketable permits as an
important step in improving the efficiency of environmental regulations.
 The primary criticism against the permits was that there is no attempt to
make geographic distinctions associated with the location of emission
of SO2.
 The first trade to occur was between a Wisconsin utility and the
Tennessee Valley Authority (TVA).
 The sale of allowances from Wisconsin to Tennessee resulted in less
pollution by the Wisconsin utility and more by TVA.
 The cost of reducing pollution by the amount of the traded allowances
must be less than the price of the allowances, or the Wisconsin utility
would not have agreed to the sale.
 Similarly, the savings in the abatement costs for TVA must be greater
than the cost of the permits.
 Both companies lowered their costs.
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Acid Deposition Policy and the 1990 Clean Air Act
 If the only impact of sulfur dioxide pollution is acid rain, the
cost of which is independent of location, then there will be
no change in environmental quality.
 If local pollution effects exist, then the trade will reduce
local environmental quality in Tennessee and increase the
quality in Wisconsin.
 A comparison will have to be made between the loss to
citizens in Tennessee and the gain to citizens in Wisconsin.
 A potential Pareto improvement is still possible if the
citizens of Wisconsin gain by more than the loss by citizens
in Tennessee.
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Acid Deposition Policy and the 1990 Clean Air Act
 Another potential problem with the acid rain provisions of
the 1990 CAAA is that not all emitters of SO2 are
incorporated into the system, and NOx is not part of any
trading system.
 It may be that obtaining greater reductions from small
emitters and mobile sources (which were not included) is
cheaper at the margin.
 The 1990 CAAA amendments did take positive steps to
reduce the acid rain problem.
 With a goal of reducing sulfur dioxide emissions by roughly
50%, Phase I of the program, which began in 1995,
developed a cap on emissions of most polluting power
plants.
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Acid Deposition Policy and the 1990 Clean Air Act
 One of the fears expressed by opponents of the Sulfur Trading Program
was that local air quality would decline in areas where most of the
electric power generation was from older plants facing higher
abatement costs.
 Although the system has lead to some patterns of trading that increase
emissions in certain areas, it does not appear that this has caused any
areas to violate the federal standards.
 The sulfur trading program has been relatively successful with long run
cost savings associated with the program estimated at $0.78 billion,
however the volume of trade has been less than anticipated.
 Factors which have contributed to this include uncertainty about the
future, obstacles to trading created by state-level regulatory agencies,
and a desire, on the part of firms, to bank emission reductions for the
future, rather than selling them today.
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Acid Deposition Policy and the 1990 Clean Air Act
 One interesting outcome of the program is that prices of
allowances have been lower than anticipated suggesting
that marginal abatement costs are lower than predicted.
 The US Environmental Protection Agency originally
predicted an allowance price of $1500 per ton, but revised
this downward to about $500 in 1990.
 Actual prices started out around $250-$300 per ton and fell
to $70 per ton by 1996.
 The price has risen in more recent auctions.
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Acid Deposition Policy and the 1990 Clean Air Act
 Table 9.2 contains a summary of the acid rain
provisions (Title IV) of the 1990 Clean Air Act, and
Figures 9.4 and 9.5 show the anticipated levels of
emissions as a result of this legislation.
 An important point to remember is that the target of
ten million ton reduction was not an optimal
reduction but rather a value supported by the
scientific research and acceptable to most members
of Congress.
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Acid Deposition Policy and the 1990 Clean Air Act
 The 1990 CAAA required NAPAP to conduct an assessment of the costs
and benefits associated with this reduction by 1996 with periodic
assessments every 4 years and to identify the levels of reduction that
will prevent adverse ecological impacts (not defined in legislation).
 Another important point is that Title IV relies primarily on command and
control provisions. The only exceptions are the trading allowances.
 The Clean Air Act also reflects a negotiated agreement between the
United States and Canada.
 The two countries entered into a "Bilateral Agreement on Air Quality" in
1991 to deal with acid deposition precursor pollutants and other types
of air pollution.
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Regulations on Mobile Sources of Pollution
 The primary regulation on mobile sources of
pollution is specifying abatement control devices
for vehicles.
 All automobiles are required to employ a catalytic
converter.
 Platinum in the converter serves as a catalyst that
lowers the ignition temperature of many of the
unburned hydrocarbons and other pollutants in
gasoline.
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Regulations on Mobile Sources of Pollution
 One problem with this command and control regulation is that it
controls all areas of the country in the same fashion, regardless of
impact of an additional units of emission.
 Additionally, it does not provide incentives to reduce pollution by
driving less, maintaining their cars, or choosing an alternative vehicle or
mode of transportation.
 Air pollution from automobiles is also indirectly controlled by Corporate
Automobile Fuel Efficiency (CAFE) standards, which specify the average
miles per gallon that must be achieved by each automobile
manufactured, where a higher MPG means less gasoline burned per
mile which means less emission.
 This standard does not reduce the number of miles driven and may
actually induce greater mileage.
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Regulations on Mobile Sources of Pollution
 Mills and White suggest an alternative policy which would
tax cars based on the total amount of pollution that they
generate each year.
 An annual diagnostic test would determine the emissions
per mile and this multiplied by the odometer reading would
give annual emissions.
 A combination of federal and state taxes could be used to
account for regional difference in ambient air quality.
 This would impose financial incentives on consumers to
drive less, live closer to work, and develop lower polluting
automobiles.
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Energy Policy and the Environment
 US Presidential Administrations have integrated
environmental policy and energy policies usually
with two major goals:
Increase domestic supplies of energy and reduce
dependence on foreign oil.
Promote a cleaner environment by requiring energy users
to utilize cleaner technologies.
 These policies have had a mixed record of success.
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Energy Policy and the Environment
 One dominant factor in the failure of US
energy/environmental policy is that it fails to allow
the cost of energy, particularly imported petroleum,
to reflect its true social cost.
 This cost has two components:
The social cost of dependence on insecure imports of
petroleum.
The environmental cost of energy use.
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Energy Policy and the Environment
 Energy policy has traditionally been designed to
keep energy costs low.
 A higher cost associated with energy use would
result in the development of alternatives to fossil
fuels, a reduction in the amount of pollution per
unit of energy used, a reduction in energy use, the
development of more energy efficient technologies
and a reduction in oil imports.
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Energy Policy and the Environment
 There is a fundamental disparity between the private cost of
energy use and the social costs associated with its use.
 There are a variety of ways to eliminate this disparity.
 The least costly would be a comprehensive series of market
pollution permits or a system of per unit pollution taxes.
 A combination of both permits for large stationary polluters and
taxes for mobile sources may be best.
 Externalities in the production of energy could be addressed
with liability and bonding systems.
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Energy Use and Environmental Taxes
 Fuel taxes may be a second best solution to pollution taxes
or permits.
 A tax added to the price of fuel based on the average
amount of pollution of the fuel would provide an incentive
to burn less fuel and encourage energy efficiency.
 However, fuel taxes do not provide incentives to reduce
emissions per unit of fuel burned.
 In addition, many people object to being taxed on both
philosophical and practical grounds.
 Philosophical grounds center on the belief that government is too
big and intrusive.
 Practical grounds center around the idea that government
spending tends to be wasteful.
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Energy Use and Environmental Taxes
 The importance of increasing the price of fuel can be seen both in
pollution problems arising from energy use and the lack of progress in
developing alternative energy sources.
 Alternative sources of energy include solar power, geothermal power,
wind power, and liquid fuel from renewable sources such as ethanol
and methanol from a variety of plant sources.
 While alternative sources of energy are generally less polluting than
fossil fuels, alternative energy technologies are more expensive for
energy users than coal or oil, so they have not become established as
important sources of energy.
 Alternative fuels and energy technologies would be significantly
advanced if the price of fossil fuels rose to incorporate the full social cost
of these fuels as illustrated in Figure 9.6.
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Energy Use and Environmental Taxes
 The marginal private cost curve for all fuels is constructed
by horizontally summing the MPC curve for alternative fuels
and the MPC curve for oil.
 The market equilibrium is tl where total fuel MPC is equal to
the market demand curve.
 The social optimum, t2 occurs at a lower output where total
marginal social cost is equal to market demand.
 MPC plus an externalities tax or other options would bring
private and social optimum together.
 At this lower output level, oil usage declines and alternative
fuel use increases.
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The Macroeconomic Impact of Fuel Taxes
 Are low energy prices a requirement for U.S. economic success?
 Table 9.3 lists gasoline prices in US dollars (current, not inflation
adjusted) per liter for selected developed countries.
 It is clear that other economies with higher energy prices (based on
higher taxes) have strong and growing economies.
 One of the reasons for the undesirable macroeconomic impact of high
prices in the 1970s was the fact that the price change was so sudden.
 This suggests that implementing increased gas taxes over time will not
hurt the economy and will allow consumers and producers to
incorporate the higher prices into their future plans.
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The Macroeconomic Impact of Fuel Taxes
 If taxes are efficiently utilized, the tax revenue generated
could be used to reduce taxes in other areas of the
economy, for example, income taxes.
 This reduction in income taxes could lead to greater
productivity which would offset, at least partially, the
negative impact of fuel taxes.
 A pollution tax, system of marketable pollution permits, or
fuel taxes will cause less of a negative impact on the
macroeconomy than a corresponding increase in the prices
from OPEC monopoly power.
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Transition Fuels and the Future of Fuels
 Many people believe that sometime in the future there will
be radically different sources of energy.
 The question is “How do we get from the present time to the
time when these innovations in energy are available, or
what should be our transition fuel?”
 The mechanism which will move the economy from one fuel
to another is rising prices in the market.
 As the marginal extraction cost of oil increases relative to
the marginal extraction cost of coal, the opportunity cost of
using oil decreases.
 The transition point to a new fuel is when total marginal
cost of oil (MEC+MUC) is equal to total marginal cost of
coal.
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Figure. 9.7. - Fuel Transition
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Transition Fuels and the Future of Fuels
 Policy makers have been concerned with managing the
transition from one source to another.
 One concern is that the market will not adequately spur
research and development into new technologies.
 Another is the continued policy of abundant, cheap energy
at a low price.
 A more recent concern is that if environmental externalities
are not reflected in the market price, then transition to
cleaner fuels will occur later than socially optimal.
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Transition Fuels
 The Carter administration adopted a policy that defined coal
as a transition fuel but expressed concerns about high levels
of pollution from burning coal changed this choice.
 Viewed as the cleanest of fossil fuels, another possibility is
deep natural gas, which is thousands of feet deeper and
more expensive than conventional gas.
 However, if all fuels included all social costs in their prices,
then the market would pick the fuel with the lowest social
cost as the transition fuel.
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Energy and the Third World
 The real energy crisis is in the Third World nations, where
the economies are much less capable of adjusting to price
shocks associated with oil price increases.
 Often Third World countries have to use much needed
foreign reserves to purchase oil which leads to borrowing
for development projects.
 The increase in the price of fossil fuels has forced a greater
reliance on fuel wood which has contributed to a growing
rate of deforestation.
 Environmental externalities from energy use have also
contributed to dreadful environmental quality.
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Summary
 Although the Clean Air Act and other legislation in
the US has had some impact in reducing the
negative consequences of energy use, much
progress needs to be made.
 Internalizing the external cost of emissions and
national security externalities through permits and
taxes will generate a series of reactions which lead
to higher social welfare.
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