Transcript Introduction to micro-economics

Introduction to micro-economics
Externality - Pollution
Externalities
• External cost (negative externality)
– A cost that arises from an activity undertaken by an
individual, firm or other economic agent and that is borne
by others because the cost is not incorporated in the
market price the agent pays.
• External benefit (positive externality)
– A benefit received by others that arises from an activity
undertaken by an individual, firm or other economic agent
for which the agent is not compensated in the market
price paid for the good or service provided.
• An externality is an impact (cost/benefit) on others
arising from production or consumptions , which is not
reflected in prices.
Private costs and social costs diverge
LO1: External Costs and
Benefits and Their Affects on
Resource Allocation
Ch10-2
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Externalities Distort the
Allocation of Resources
• Does the honeybee keeper face the right
incentives? (Part 1)
– When the bee-keeper has more hives, the bees
pollinate the trees in the orchard more thoroughly,
increasing the yield.
– Positive externality.
• Does the honeybee keeper face the right
incentives? (Part 2)
– When the bee-keeper has more hives, the more
students and nursing home residents will be stung by
bees.
– Negative externality.
LO1: External Costs and
Benefits and Their Affects on
Resource Allocation
Ch10-3
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Externalities and Resource Allocation
Individuals considering only their own costs and
benefits will tend to engage in….
– Too much in activities that generate negative
externalities.
• Market Price overestimates the benefits of the activity.
• Prices do not include social costs
– Too little in activities that generate positive
externalities.
• Market Price underestimates the benefits of the activity.
• Price does not include the benefits
LO1: External Costs and
Benefits and Their Affects on
Resource Allocation
Ch10-4
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FIGURE 10.1: How External Costs and Benefits Affect
Resource Allocation
Social MC =
Private MC + XC
S
XB
Social demand =
Private demand + XB
Private MC
MC
XC
Private
demand
D
Qsoc Qpvt
Qpvt Qsoc
The market equilibrium level of output (Qpvt) is larger than the socially optimal
level (Qsoc) for products accompanied by external costs [panel (a)] but smaller
than the socially optimal level for products accompanied by external benefits
[panel (b)].
LO1: External Costs and
Benefits and Their Affects on
Resource Allocation
Ch10-5
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Coase theorem
• The Coase theorem states that it is not necessary to assign liability or
regulate pollution
• Provided that
– transactions costs (the costs of negotiation) are not too high,
socially efficient equilibrium can be achieved regardless how the
property rights are assigned.
• It does not matter whether the chemical factory has the right to
pollute or the salmon fishery has the right to water that is not
polluted.
• The Coase theorem fails to work because one party believes they
should not need to negotiate and when the transactions costs exceed
the benefit either parties could obtain by negotiation.
“Coase makes the point that which ever way the law interprets the
property rights, as long as these rights are well defined and the
transactions costs of enforcing and transferring them are not too
great, society's resources will be used most efficiently by just letting
private agents work out these problems to their own mutual benefit.”
http://faculty.wcas.northwestern.edu/~mwitte/pf/handouts/coase.html
Coase Theorem Example
• “Consider a railroad that passes through wheat fields. The
passing trains let off sparks which can burn the wheat. If
the legal rights are on the side of the farmers, then they
could require the trains to buy and install spark catchers to
eliminate these fires. However, if that is expensive (i.e.
more than the value of the burned wheat), the train
owners may just pay the farmers for the damage done to
the crops. If the legal rights are with the trains, the farmers
may just put up with burned crops or (if that is expensive)
they could pay the trains to put on spark catchers. Either
way, the socially efficient outcome (install spark catchers or
burn crops) is what happens and the legal rights just
determine who has to pay.”
• C:\Users\gmason.PRAINC\Documents\Pavtub
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and the Coase Theorem - YouTube.mp4
Legal Remedies for Externalities
• Costless negotiation and full information are very
strong assumptions.
– Negotiation is not always practical because:
• Many potential participants.
• Contracts can be difficult / costly to enforce.
• Strategic behavior / bluffing .
• In practice, many laws and regulations try to
solve externality problems.
• The burden of adjustment is often assigned to
those who can adjust at the lowest cost or who
have the fewest resources to object.
Lo2: Policies to Offset
Externalities
Ch10-9
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Optimal Amount of Externalities
• The optimal amount of negative externalities
is not necessarily zero.
• Eliminating pollution has both benefits and
also costs
– The best policy will eliminate pollution until the
cost of further abatement equals the benefit of
further abatement.
– The cleanup effort should be expanded only until
the marginal benefit equals the marginal cost.
Lo3: Optimal Externality is
not Zero
Ch10-10
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Property Rights and the Tragedy of the
Commons
Property Rights
• People who grow up in the industrialized nations
tend to take the institution of private property for
granted.
• Property rights are much more complex than simple
possession.
• The idea is much broader than land or housing
(termed real property or real estate)
Slavery is the expropriation of the individual’s right to sell his/her
labour
• The extent of property rights has, moreover,
changed substantially over time in advanced
industrial countries.
• There are many unpriced resources that nobody
owns.
LO4: Tragedy
of the
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Commons and Remedies
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Tragedy of the Commons
• The tendency for a resource that has no price
to be used until its marginal benefit falls to
zero.
– One person’s use of commonly held property
imposes an external cost on others, reducing the
property’s value.
• One solution: private ownership of the entire
resource.
– Single private owner will “internalize the
externality”.
LO4: Tragedy of the
Commons and Remedies
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When Private Ownership is Impractical
• Defining private ownership rights does not always
solve the tragedy of the commons.
– Why are blackberries in public parks picked too soon?
– Why does London, England, impose a tax on every
vehicle that enters the central business district during
business hours?
• Enforcement of property rights may not be
feasible.
– Harvesting whales in international waters.
– Controlling multinational environmental pollution.
LO4: Tragedy of the
Commons and Remedies
Ch10-14
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London Congestion Charge
•
•
The London congestion charge is a
fee on most motor vehicles
operating within the Congestion
Charge Zone (CCZ) in between
07:00 and 18:00 (M-F).
Claimed direct benefits
–
–
•
Reduced travel time (diversion to transit)
Reduced vehicle emissions leading to
lower pollution (CO2 and NO2)
Claimed indirect
–
–
Increased revenues
Increased use of alternative transit
(bicycles)
Change in cars on the street
• Blue is increase
• Red decrease
• Green – no change
Change in bicycles on the street
• Blue is increase
• Red decrease
• Green – no change
10.3 Climate Change and Greenhouse
Gases
Taxes to reduce pollution
Basic Tax Structures
• Income taxes (progressive, regressive,
proportional or flat tax)
• Consumption (Sales and GST)
• Ad valorem (property, inheritance)
• Poll tax (head tax – equal tax per person,
business, household)
Green Taxes
• Form of consumption tax
• Some advocate replacing existing taxes on employment,
incomes and profits (‘goods’) with taxes on energy use (‘bad’)
• This is claimed to result in
– better overall national economic performance;
– higher levels of employment;
– and a cleaner environment.
• The goal is to shift the balance between human resources and
natural resources.
• Taxes are well known to shift resources:
– Income taxes tend to reduce work effort
– Sales taxes reduce consumption (cigarettes)
– Carbon taxes are intended to reduce use of fossil fuels
Green Taxes
• Problems
– Green taxes are regressive because (hit poorer
people relatively harder than richer).
– A tax on natural gas raises the cost of heating,
cooking and lighting, it will consumer a higher
proportion of disposable income and poor people
would find it harder to pay
– The effect is greater if we reduce income and
prfits taxes tp really force the shift for which there
are many exemptions
Rehabilitating the Green Tax
1.
2.
3.
Some studies show that redistributing the surplus as an
eco-bonus creates a progressive tax.
Green taxes at the retail level are regressive, but imposed
at the upstream are less so it affects all incomes – salaries,
rents, profits, dividends, which tend to fall more of richer
households.
Green taxes should form part of a broader tax reform. For
example a general shift to wealth taxes and a move to value
added taxes (GST) and away from income taxes.
Caution: Progressivity in taxation is not the only goal.
Other goals must be sustainability (resource allocation is
not disturbed to erode the tax base), ease of
administration, and enforcement.
Area a
Total costs
minimized
(area a + b)
Area b
The concept of cost
minimization for
abatement is related to the
concept of elasticity in
demand
The basic math rests on
geometry and the area
defined by the rectangle
that shows the marginal
abatement cost/tax and
emission level
Allowing emissions
costs nothing E0 = 50
MAC = marginal abatement cost
Optimal Green Tax: MAC = MD
MD = marginal social cost of
damages
Total cost of damages
foregone = e + f (total cost of
abatement + avoided losses
to the pollutee)
The net benefit is f
Total tax paid by the
polluter is a+b+c+d, plus
the abatement cost (e).
Taxes are more costly to
the firm than standard
Cost of a standard (set at
E*) is just e.
Why tax?
What dangers exist in
using a tax
Technology lowers the MAC
Cost of tax + abatement
creates an incentive to invest
in new technology
Industry 1: total cost = a+b+c+d+e
Industry 3: total cost = b+d+e
If the difference is technology, the gain
is area a+ c
Taxes to reduce pollution
Basic Tax Structures
• Income taxes (progressive, regressive,
proportional or flat tax)
• Consumption (Sales and GST)
• Ad valorem (property, inheritance)
A tax imposed on industry
will cost differentially
depending on abatement
costs of each firm (H and L)
Total abatement is 80 + 20
Kg/mo
An emission tax may have
a lower social compliance
cost than a uniform
standard
When abatements costs vary, a tax may be more cost-effective ($/kg controlled)
What is the least costly way to cut
pollution by half?
•
•
•
•
If tax is $40/tonnes, Sludge Oil would
continue to use process A and Northwest
Lumber, would switch to process B, cut
pollution by 1 tonnes only.
If tax is $101/tonnes, Sludge Oil would now
switch to process B and Northwest Lumber,
would switch to process D, cut pollution by
4 tonnes.
The total cost of the reduction would be
only $280/day ($100/day for Sludge Oil and
$180/day for Northwest Lumber), which is
less than previously.
The firm’s marginal benefit from any activity
that reduces its pollution by one more
tonne is exactly the amount of the tax (MB =
MC).
Note – different way
to show MAC
MB = MC
Note that this is a different way to
represent MAC
Lo2: Policies to Offset
Externalities
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What will be the price of pollution
permits?
•
•
•
•
Suppose the government could give two
permits free of charge to each firm,
allowing them to then sell or purchase
permits.
If Sludge Oil uses the permits, it will
produce at point c, with the MAC at
$400/day. If a permit on sale for $300, it is
profitable for Sludge oil to buy it and
produce at b.
If Northwest Lumber uses the permits, it
will produce at point C, with the MAC at
$100/day. If it can sell a permit for $300, it
is profitable for Northwest Lumber to sell
it and produce at D.
It has the same result as a tax method.
Lo2: Policies to Offset
Externalities
Ch10-28
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Using taxes to drive alternative energy
• A claimed benefit of green taxes is to promote
the development and adoption of alternative
energy
• It does this by
– Changing the relative price of conventional and
alternative energy
– Direct investments (ear marked taxes)
• Can government make better investments
than private sector
Costs of alternative energy
Table 1: Price range of renewable electricity by technology (2007)
Cents / kWh*
Technology
5.6 – 9.5
Wind
6.1 – 11
Geothermal
4.5 – 13
Biomass
23 – 42
Solar PV
27 – 96
Wave power
20 – 39
Tidal
2.2 – 11
Hydro power (including large-scale)
* Figures were converted to Canadian dollars using the exchange rate of June 8,
2009 (1.1161).
Wind Power
Environmental Policy
and Externalities
When negotiation between the private parties affected is
costly or infeasible, goods with external costs tend to be
overproduced.
Greenhouse Gases.
– Public policy towards Greenhouse Gases:
• Reductions to be distributed so that marginal abatement cost —
that is, the cost to a polluter of reducing Greenhouse Gases by one
unit—is the same for all polluters.
• If different polluters have different marginal costs of pollution
abatement, those approaches will not be efficient.
• Taxing pollution.
• Pollution permits.
Lo2: Policies to Offset
Externalities
Ch10-33
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Incentives and subsidies
• The reverse of taxation are rewards for good
behaviour
• Subsidies are design to lower the costs of
adopting new technologies or uses that are
more expensive (private costs), but are
believed to create social benefits.
• Common examples
– Incentives to insulate
– Cash for hybrid purchase
Selling Electricity Back to the Utility
Feed-in tariff – payment is above retail, and as the percentage of adopters increases, the FIT is
reduced to the retail rate. The extra payment comes from the tax-payer
Net metering – payment is always at the retail rate, and allows producers to use electricity at a
different time than when it was generated.
Power Purchase Agreement – treats epectricity producer as a conventional supplier below the retail
rate, although some sources (solar) can be higher, because solar tends to be produced closer to
during peak demand.
Summary of main policies for pollution
control
Problems with pollution control policies
• Moral suasion is “preachy” and easy to ignore
• Taxes tend to create adversarial situations between
government and citizens (households and businesses)
• Subsidies are a transfer from the tax payer to the polluter and
are politically difficult is we reward polluters.
• The private market approach (Coase Theorem) requires
assignment of rights and willingness of parties to negotiate
• Transferable development rights
Transferable Development Permits TDP
• This is the core idea behind cap and trade programs
• TDP is a government created market where
– A total emissions is set for everyone
– everyone is allowed to pollute to a certain maximum for their
operasiton, and no more.
– those who pollute less than this maximum are allowed to sell the right
to others who pollute more.
• The idea is that to pollute more than the standard imposes an
additional cost. This will increase the incentive to cut back
through introduction of new technology or changed practices.
Rights
Non-pollutors
Polluters
$
MACB
MACA
In this case, pollution credits are awarded in proportion of the level
emitted – 30 for A and 50 for B to reach a total of 80.
A receives 30 credits and B receives 50 credits.
An incentive exists to sell/buy if the MACs differ at the emission levels.
TDP – key issues
• Can serve to define a target level of emissions like standard
• Cost effective since the polluters must negotiate the trade.
• It is not necessary for the MACs to be known – fairly good bet
that they are different.
• Once the target is set, market transactions will identify the
MAC
• As long as MACs differ, and prices “split” the difference,
trading should occur.
• Both polluters will enjoy cost savings (gains from trade)
TDP – challenges
1. Initial rights allocation
– cannot flood the market with rights
– what rules are used to allocate rights
•
•
Equal
Proportional to pollution
– Are rights free or sold?
– The key is to distribute rights widely
TDP – challenges
Trading rules
– Who is allowed to trade (best outcomes allow
free trades, however regulators usually want to
meddle).
– Should advocacy groups be allowed to buy and
burn? This will restrict supply drive up the price
and discourage trading
– If the minimum is too low or two high… policy
fails
TDP – challenges
3. Non-uniform/mixed emissions
Multiple trading
zones create
complexity
Without the
zones, those
polluters down
wind may not
participate
TDP – challenges
• Competition
– Many buyers and sellers ensure efficient markets
– TDP applied to specific areas may limit the
numbers interested in participating in the market
– This is termed a “thin” market and is prone to
distortion (domination by a few sellers or buyers)
TDP Challenges
Asymmetric Information
• Basic private-value model - bidders know their own valuation, but no one
else’s
• Pure common-value model – everyone values the item identically, but
bidders have different information (private) on the true value
Example: Information on the amount of oil in the ground many vary among bidders
Example: Pollution rights may depend on scope of contaminants to be covered (just COx or all
GHGs)
• Insider information can distort any market including an auction market
• Nash Equilibrium: My bid depends on what I think your bid will be.
Example: If each market participant behaves as if there is no benefit by changing his or her
strategy and everyone else does the same, the current set of market prices constitute a Nash
equilibrium. Stated simply, A and B are in Nash equilibrium if A is making the best decision,
taking into account B’s decision, and B is making the best decision, taking into account A's
decision.
Objections to TDP
• Utilities that need to buy TDPs will pass it on
as a tax (if they are allowed) and those who
gain credits will increase profits.
• Firms can enter an industry to claim credits
(scam the system).
• The market for TDPs must be efficient
Seclected video
http://www.youtube.com/watch?v=oqJO8HwxTkg&feature=related
http://www.youtube.com/watch?v=uSNQzSjb38g
https://www.youtube.com/watch?NR=1&v=y7veRksc_Yk&feature=endscreen
Chapter Summary
• Externalities are the costs and benefits of activities that accrue
to people who are not directly involved in those activities.
• According to the Coase theorem, the allocation of resources is
efficient in such cases because the parties affected by
externalities can compensate others for taking remedial action.
• The optimal amount of pollution reduction is the amount for
which the marginal benefit of further reduction just equals the
marginal cost.
• Defining and enforcing private rights that govern the use of
valuable resources is often an effective solution to the tragedy
of the commons.
• The difficulty of enforcing property rights in certain situations
explains a variety of inefficient outcomes.
Chapter Summary
Ch10-47
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Chapter Summary
• An efficient program for reducing pollution requires that
marginal abatement cost be the same for all polluters.
• Either a properly designed tax on pollution or a system of
pollution permits will have this property.
• Situations in which people’s rewards depend on how well
they perform in relation to their rivals can give rise to
positional externalities.
• Positional externalities tend to spawn positional arms
races—escalating patterns of mutually offsetting
investments in performance enhancement.
• Collective measures to curb positional arms races are
known as positional arms control agreements.
Chapter Summary
Ch10-48
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