Reading material for Second year economics students

Course name: Natural resource and environmental economics

Course code: Econ-M2091
Credit hours: 3hrs
Academic year/semester: 2019/20, Second semester

By: Bedada Teressa (M.Sc), Mekelle University, Department of Economics

 Chapter Five

Economics of Pollution Control

Outline
• The following points will be presented in this chapter
– Introduction: fundamental questions?

– Categorization of pollutants or pollutant taxonomy

– Market versus efficient allocation of pollution, and

– Cost-effective pollution control instruments (policy

responses)

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 Introduction
• In the preceding chapters we have discussed the
economic environmental relationships.
– One side depicted the flow of mass and energy to the
economic system,
– while the other depicted the flow of waste products
back to the environment.
• In the last few chapters we dealt extensively with
– achieving a balanced set of mass and energy flows;
– now we examine how a balance can be achieved in the
reverse flow of waste products back to the
environment

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• Two questions must be addressed:
1. What is the appropriate level of flow? and,
2. How should the responsibility for achieving this flow
level be allocated among the various sources of the
pollutant when reductions are needed?
• In this chapter we discuss
– the policy approach to controlling the flow of these
waste products by developing a general frame-work
for analyzing pollution control to define efficient and
cost-effective allocations for a variety of pollutants.

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5.1 Pollutant taxonomy
• The amount of waste products emitted
determines the load upon the environment; and
• The damage done by this load depends on the
capacity of the environment to assimilate the
waste products.
– We call this ability of the environment to absorb
pollutants its absorptive capacity.
– If the emissions load exceeds the absorptive
capacity, then the pollutant accumulates in the
environment.
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• Pollutants for which the environment has little or no
absorptive capacity are called stock pollutants.
– They accumulate over time as emissions enter the
environment.
– Examples, non-biodegradable bottles tossed by the
roadside; heavy metals, such as lead, and persistent
synthetic chemicals, such as dioxin and PCBs
(polychlorinated biphenyls).
• Pollutants for which the environment has some
absorptive capacity are called fund pollutants.
– As long as emission rate does not exceed the absorptive
capacity of the environment, pollutants do not accumulate.
– Example, CO2 is absorbed by plants and the oceans.
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• Pollutants can also be classified by their zone of influence,
defined both horizontally and vertically.
• The horizontal dimension deals with the spatial domain
over which damage from an emitted pollutant is
experienced.
– The damage caused by local pollutants is experienced near the
source of emission,
– while the damage from regional pollutants is experienced at
greater distances from the source of emission.
– The limiting case is a global pollutant, where the damage affects
the entire planet.
– The categories are not mutually exclusive; sulfur oxides and
nitrogen oxides, for example, are both local and regional
pollutants.

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• The vertical zone of influence describes whether the
damage is caused mainly by ground-level
concentrations of an air pollutant or by concentrations
in the upper atmosphere.
– For some pollutants, such as lead or particulates, the
damage caused by a pollutant is determined mainly by
concentrations of the pollutant near the earth’s surface.
– For others, such as ozone-depleting substances or
greenhouse gases, the damage is related more to their
concentrations in the upper atmosphere.
• Each type of pollutant requires a unique policy
response. The failure to recognize these distinctions
leads to counterproductive policy.

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5.2 The Efficient Allocation of Pollution

• Pollutants are the residuals of production and

consumption.
– They must eventually be recycled or returned to
the environment in one form or another since their
presence may depreciate the service flows
received,
– An efficient allocation of resources must take this
cost into account (that is the efficient allocation of
pollution depends on the nature of the pollutant)

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Stock Pollutants
• The efficient allocation of a stock pollutant must take
into account the fact that the pollutant accumulates over
time and the damage caused by its presence increases
and persists.
– There is an interdependency between the present and the
future, since the damage imposed in the future depends on
current actions.
• The damage caused by pollution can take many forms.
– Human health can be adversely impacted even leading to
death.
– Other living organisms, such as trees or fish can be harmed.
– Damage can even occur to inanimate objects; example, acid
rain causes sculptures to deteriorate.

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• The efficient allocation in these circumstances can be
established easily using the intuition we gained from the
discussion of depletable resource models.
• Suppose that the production of product X generates a stock
pollutant.
– The amount pollution can be reduced, but it takes resources
away from the production of X.
– That is, the stock of pollutants remains in the environment and
the damage persists as long as production of X proceeds.
• The dynamic efficient allocation is the one that maximizes
the present value of the net benefit.
– The net benefit at any point in time t, is equal to the benefit
received from the consumption of X minus the cost of the
damage caused by the presence of the stock pollutant in the
environment.

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• Stock pollutants are the other side of the
intergenerational equity coin from depletable
resources.
– Current generations create a burden for future
generations by using up resources, thereby diminishing
the endowment.
– Stock pollutants can create a burden for future
generations by passing on damages.
– Though neither of these situations automatically
violates the weak sustainability criterion, they clearly
require further scrutiny.

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• The emission of the pollutant created by the
production of X - controlled through introduction of
technologies (such as recycling)
• The price of X and the quantity consumed would
remain constant
• Technological progress to lower the marginal damage
cost
– Reduce the amount of pollutant generated per unit of X
– Recycle the stock pollutant rather than inject
– Innovate ways of rendering the pollutant less harmful
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Fund Pollutants
• To the extent that the emission of fund pollutants
exceeds the assimilative capacity of the environment,
– they accumulate and share some of the characteristics of
stock pollutants
• When the emissions rate is low enough, however,
– the discharges can be assimilated by the environment, and
future damage may be broken
• For the fund pollutants, the efficient level of emission
obtained where the marginal damage to the
environment exactly equals the marginal cost of
pollution emission control (MD = MC).

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• Pollution control is analyzed from the perspective of
minimizing costs
– Pollution Damage Costs - damage
– Pollution Control/Abatement Costs – cleanup
• Pollution (Marginal) Damage Costs
– Damages increase with the amount of pollution emitted to
the environment
• Pollution (Marginal) Control Costs
– Abatement cost increase with the amount of pollution that
is controlled/cleaned/abated; but, decrease in the control
cost rises the emission

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• The efficient allocation is represented by Q*, the point
at which the damage caused by the marginal unit of
pollution is exactly equal to the marginal cost of
avoiding it.
– Greater degrees of control (points to the left of Q*) are
inefficient because the further increase in avoidance costs
would exceed the reduction in damages, hence, total costs
would rise.
– Similarly, levels of control lower than Q* would result in a
lower cost of control but the increase in damage costs
would be even larger, yielding an increase in total cost.
– Increasing or decreasing the amount controlled causes an
increase in total costs; thus, Q* must be efficient.

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• Factors that determine the position of Marginal
Control Cost Curve are:
• Production technology
• Technology of pollution control
• Input use
• Pollutant/Residual recycling methods
• Factors affecting the Marginal Damage Cost:
• Changes in people’s preference for environmental
quality
• Changes in population
• Discovery of new treatment(s) to damage
• Change in the nature of assimilative capacity of
environment

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5.3 Environmental policy instruments

• This topic is the key in this course in terms of

conceptual matters
– The market system, left to itself, is likely to
malfunction when matters of environmental
pollution are involved
– This brings us to the policy question: ‘If we do
not like the way things are currently turning out
(economic activity and pollution), what steps
should be undertaken to change the situation?
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• The policy problem includes a number of
closely related issues
– identifying the most appropriate level of
environmental quality we ought to achieve
– how to divide up the task of meeting
environmental quality goals
• If we have many polluters, how should
we seek to allocate among them an
overall reduction in emissions?
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• Does market lead to efficient allocation of pollution?
– Damage costs are externalities
– Control costs are not externalities (they are costs to a
firm/s)
• Therefore, what is cheapest for the firm is not always what is
cheapest for society as a whole
• Firms that attempt to control pollution unilaterally are placed
at a competitive disadvantage
• Hence, market fails to generate efficient level of pollution
control and penalizes firms that control pollution
– Thus, a policy response is essential to arrive at optimal
pollution control/management

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 Defining a Cost-Effective Allocation for
Uniformly Mixed Fund Pollutants
• A uniformly mixed fund pollutant - damage depends
on the total amount of pollutant entering the system
(does not matter where the source is)
• Policy can focus on controlling the total amount of
emissions - that minimizes the cost of control
• The cost-effective allocation is found by equating the
Marginal Control Costs of the sources or firms
– Total cost is the area under the marginal control cost
curve,
– total costs across the two firms is minimized by
minimizing the two areas and found by equating the two
marginal costs as it indicated in the figure bellow

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Example is:
• total amount of pollution from the two sources=30;
• government wants a reduction of 15 units

The first source cleans

up ten units, while the
second source cleans
up five units

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• The control authority might use several policy
instruments to achieve cost effective allocation once the
allocation is defined.
– Sources have options for controlling the amount of pollution
– Cheapest method of control will differ among industries and
among plants in the same industry
– Selection of the cheapest method requires information on the
possible control techniques and their associated costs
– Unlike plant managers government authorities responsible for
meeting pollution targets may be constrained of information –
difficult for control authorities

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(i) Emission Standards
– This approach is known as a command-and-control
approach, and is a legal limit on the amount of the
pollutant an individual source is allowed to emit
– In the absence of adequate information (such as in
the previous figure) the options are to allocate each
source an equal reduction
– But the strategy would not be cost-effective - total
costs would increase if both sources were forced to
clean up the same amount

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• There are other policy instruments which allow
the authority to allocate emissions reduction in a
cost-effective manner even when it has no
information on the magnitude of control costs
• Such policy approaches rely on economic
incentives to produce the desired outcome
• The two most common approaches are known as;
– emissions charges, and
– emissions trading

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(ii) Emission Charge
• An emission charge is a per-unit of pollutant fee
collected by the government
– Charges are economic incentives
• Total payment could be found by multiplying the
fee times the amount of pollution emitted
– Emissions charges reduce pollution since it rises firm’s
cost; hence, the source seeks ways to reduce or control
its pollution emission to save its money
• If the firm is not reducing its emissions it would be
forced to pay the full amount for the emission
multiplied by the rate

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Each firm will independently reduce emissions until
its marginal control cost equals the emission charge,
and this yields a cost-effective allocation

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• Faced with an emissions charge T, the second source
would clean up 5 units and first source would clean up
10 units
• Since they both face the same emissions charge, they
will independently choose levels of control consistent
with equal marginal control costs
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• Difficulty with this approach - determining how high
the charge should be set - to ensure the resulting
emission reduction is at the desired level
• What ever the case, emission charges:
– cost effective allocation of the control responsibility
– stimulates the development of newer, cheaper means of
controlling emissions
– promoting technological progress
• With an emissions charge system, the firm saves money
by adopting cheaper new technologies (otherwise
sources may hide technology)

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• As long as the firm can reduce its pollution at a marginal
cost lower than T, it pays to adopt the new technology
• The firm saves A and B by adopting new technology and
voluntarily raises its emissions reduction from Q0 to Q1

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(iii) Emissions Trading
• All sources are allocated allowances to emit either
on the basis of criterion or by auctioning
– allowances are freely transferable
• Equilibrium price will be the price at which
Marginal Control Costs are equal for both (or across
all) firms
• Market equilibrium for an emission allowance
system is the cost-effective allocation
– Example: governments want to arrive at 15 units that
shall be cleaned
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 • Source 1 is allocated 7 allowance – must clean 8 units
• Source 2 is granted 8 allowance – must clean 7 units
• Both firms have incentive to trade
• MCC for second source is higher (C) than the first (A)
• Second source could lower its
cost:
• if it buys allowance at price lower
than C; and
• First source would be better off:
• if it sells allowance higher than A
• Transfer of allowances would take
place
• until the first source had only 5
allowances left while the second
source had 10 allowances and
controlled 5 units
• The allowance price
• would equal B - allowance market
would be in equilibrium MC1=MC2

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(iv) Liability rules
• They allow the costs of damage to be attributed to the
agent who caused the damage
– Originator of damage will be forced to pay - will not be able
to transplant costs of his action on others
– Tend to bring private and social costs into line - efficient
social institution for dealing with negative externalities
• Liability is consistent with market system-introduce an
incentive to prevent damages to third parties
– Originator of damage can expect to be liable for damage -
attempt to avoid damages, and is an attractive policy
instrument in a market economy

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Discussion Questions
1. Explain and graphically show the
determination of optimal depletion level for
stock and fund pollutants.
2. however it is impossible to limit the pollution
emission rate to zero, economists suggest
different mitigation strategies.
– Discuss these strategies and are those strategies
ensure environmental sustainability over time?

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