Chapter 6:

Pollution control
Lecturer: PhD Nguyen Thi Thanh Huyen
 Pollution control
I. Property right approach (Coase
theorem)
II. Command and Control approach
(CAC)
III. Economic incentives approach
(Economic instruments)
I. Property right approach
Coase Theorm
Regardless of who holds the property
rights, there is an automatic tendency to
approach the social optimal via
bargaining.(Ronald Coase -1960)
Conditions:
Property right is clearly assigned.
Bargaining is possible for Polluters and
sufferers.
Illustration of Coase theorem
Using MNPB and MEC
Illustration of the Coase theorem
Using MAC and MDC
 Limitations of the Coase theorem
The Free Rider effect
The Holdout effect
Public choice vs. Private choice
A practical application
The problem of equity
The free rider effect
Environmental issues affect many parties
E.g. 50 downstream communities are
affected by pollution from factory.
Assume the polluter has the right to
pollute.
The all 50 affected communities can then offer
compensation for reducing pollution. But
which community will pay what share?
No single community or group of community is
likely to step forward to pay the whole bill.
In fact many hang back and waiting for other
community to pay the bill and supply the rest
with free pollution control benefit
The Holdout effect

Similar to problem above, but if the

communities have the right to be free from
pollution and factory must compensate
them for any pollution emitted
Who will determine how much
compensation each community receives?
Anny single community can demand a
much higher rate of compensation
=> hold out effect
Public choice vs. Private choice

When many parties are affected, the

government might set standard for water
rather than make it pure market solution.
=>Public choice rather than Private
choice.
A practical application

In fact, it is difficult to have clear

assignment of property right. Natural
resources are usually belong to the
government.
The transaction cost in reality is quite
high
The problem of equity

If the community suffered from pollution

is a low income community, then they are
not able to “buy off” the polluter.
In this case, the solution is not
independent of the assignment of property
right.
II. Command and Control approach
The dominant method of reducing pollution in
most countries has been the use of direct
controls over polluters.
This set of controls is commonly known as
command and control instruments
Next figure provides a schema by which these
instruments can be classified
 Ambient pollution
levels

Location of
emissions
Emissions output

Quantity of goods produced

Production technique

Inputs used

The pollution process

 Ambient pollution
requirements

Zoning
Emissions licenses

Output quotas

Technology controls

Input restrictions

Command and control instruments

Consists of replying on standards of various types to
bring about improvements in environmental quality

The spirit is ‘ if you want people not to do

something, simply pass a law that makes it illegal,
then send out the authorities to enforce the law’.

Violators are punished by monetary

fine/imprisonment

A standardis simply a a mandated level of

performance that is enforced in law
Emission standards as a policy tool to
control pollution_ Using MNPB and MEC
Emission standards as a policy tool to control
pollution_ Using MAC and MDC
Types of standards

Three types: ambient, emission, technology

 Ambient standards refers to the qualitative

dimensions of the surrounding environment
(ambient quality of the air/city or water
quality/river, lake)
Ambient standards are normally expressed in
terms of average concentration levels over some
period of time.
E.g: sulfur dioxide (SO )/annual mean; 24-hour
2
average basic.
Emission standards
 An emission standard is a maximum rate of effluent
discharge that is legally permitted

 Emission standards are never exceed levels applied

directly to the quantities of emissions coming from
sources

 EX: grams/unit, tons per week/year

 Settingemission standards at a certain level does not

necessary entail meeting a set of ambient standards.
Technology, techniques/practices standards

Technology standards dictates certain

decisions and techniques to be used
E.g. Technology based standards, design
standards or engineering standards…
III. Economic instruments
2.1 Pigouvian taxes
2.3 Emission charges/taxes
2.4 Subsidies
2.5 Transferable Discharge
Permit/Quota
2.6 Deposit-Refund Systems
2.7 Environmental Funding System
Advantages of economic instruments

Automatic adjustment: polluters lower their

emissions
Cost-effectiveness
Incentive for ‘environmentally friendly’
behavior
Flexibility: for both Gov. and polluters
Revenue raising
Resource conservation and transmission
2.1 Pigouvian Taxes
 2.2 Pigouvian taxes

Pigou tax is the Pollution cost at optimal level of pollution

Some problems with Pigouvian taxes
 2.3 Emission charges/emission taxes

Emission charge is a tax (or financial penalty)

imposed on pollution.
Emission charge vs. Pigouvian tax
The emission charge is based on per unit
of effluent emitted to the environment
The Pigouvian tax is based on per unit of
good or service produced.
Emission charge
MNPB and MEC using approach
Emission
charge
MAC and MDC using approach
Defining the charge level
Example
 MAC = 90-5Q
 Emission charge is 28$/unit
 What were the efficient emission level? Calculate the Total
Abatement cost
Policy instrument selection:
Emission charge or Standard?
A comparison of emissions charges and standard when abatement
costs are uncertain
 Establishing a ‘baseline’ against
which the efficiency losses from
Figure 7.2 Target setting under perfect information errors due to uncertainty can be
measured.

The efficient target, E*, is that level

of emissions which equates the
MDC marginal cost of emissions abatement
(MC) and the marginal damage of
emissions (MDC).

The shaded area represents the total

net social benefit that would be
generated at that level of emissions.:
the maximum net benefit available.

Efficiency losses from uncertainty

have in mind are those in which
t* emissions are at any level other than
M*, and so attained net benefits fall
short of their maximum level.

MAC

M*
Emissions, W
 Figure 7.3 Uncertainty about abatement costs – costs overestimated

MDC

Loss when
standard used

tH
t*
MAC
Loss when (assumed)
Emission charge used

MAC (true)

Wt W* LH
Emissions, W
 Figure 7.4 Uncertainty about abatement costs – costs underestimated

MDC

t*
tL

MAC (true)
MAC
(assumed)

WL W* Wt
Emissions, W
 Figure 7.5 Uncertainty about abatement costs – costs overestimated

MDC
t H

t*
MAC
(assumed)

MAC (true)

Wt W* LH
Emissions, W
 Figure 7.6 Uncertainty about abatement costs – costs underestimated

MD

MDC

t*
tL

MAC (true)

MAC
(assumed)

LL W* Wt

Emissions, M
General results for abatement cost
uncertainty
 What differentiates these two pairs of cases is the relative
slopes of the MC and MD functions. We obtain the
following general results:

1. When the (absolute value of the) slope of the MAC curve

is less than the slope of the MDC curve, standard are
preferred to emission charge (as they lead to smaller
efficiency losses).

2. When the (absolute value of the) slope of the MAC curve

is greater than the slope of the MDC curve, emission
charge are preferred to standard (as they lead to smaller
efficiency losses).
 Figure 7.7 Uncertainty about damage costs – damages underestimated

MD (true)

MD (estimated)

MC (true)

M* L
Emissions, M
2.4 Subsidies
Subsidy instruments are selected if MSB is
greater than MPB or the government
want to make incentive for improving
environmental quality, investing in
abatement technology.
Subsidy
In case of Positive Externality:
ÞSubsidy = Marginal Social Benefit-Marginal
Private Benefit
Subsidy
The government give polluter a subsidy to decrease
the current emission to socially optimal level.
(W*).
Total of subsidy = S (W*-Wm)
Wm: Maximum emission level
Limitations
+ Subsidies result in financial pressure on the
government
+Although an emission subsidies would have
the same incentive for each individual
source, total emissions may actually
increase due to increasing number of
emission sources.
=> Subsidies are not seen as viable
environmental policy except in special
circumstances.
2.5 Transferable Discharge
Permit/Quota
• To create a market for pollution rights.
• A permit to emit a unit of a specific pollutant (Ton,
kg)
• Each permit entitles its holder to emit one unit of the
waste material specified in the right.
• Permits are transferable: can be bought and sold

Functions of Gov. authorities:

• Determine the total allowable permits
• Decide the mechanism to distribute the initial
pollution permits
Tradable permits Total 300 permits/year
One permit: allowed to emit a ton of SO2
Cost Initial issued: 150 permits/firm
Firm 1: Point R (MAC=500)
Firm 2: Point S (MAC= 2500)

MAC1
MAC2

2500 S

E
1000
R
500 Tons of SO2 emitted/ year Firm 1

0 100 150 300

300 100 150 0

Tons of SO2 emitted/ year Firm 2
Transferable Discharge Permits
Advantages of Tradable emission permits
• Least intervention
• Cost effective, especially when many parties involved
• Provide observable market prices for environmental services.
• Applied to wide range of environmental problem

Disadvantages of Tradable emission permits

• Appropriate mechanism to distribute permits
• Ineffective when there are few participants
• Can be accumulated by firms for the purpose of deterring
entrants
Question:
A comparison 3 economic instruments:
Transferable Discharge Permits,
Emissions Charges and Standard?
2.6 Deposit refund system
Deposit-refund systems are a combination
of a product charge and a subsidy for
recycling or proper disposal (the refund).
Manufacturers or vendors of products that
are subject to deposits incur additional
costs in handling returned products, but
these costs are often partially offset by the
interest earned on deposits, unclaimed
deposits, and sales of collected, used
products.
Objectives
Objectives of a deposit system is to
discourage illegal or improper disposal.
Waste products that are discarded improperly
have higher social costs than those disposed
of properly, since such discards can become
an eyesore or even an environmental or
health threat. Improperly discarded waste is
also quite expensive to redirect to the legal
waste stream.
E.g. Applied to beverage containers
7. Deposit refund model
PrivateDisposal Cost: Opportunity cost
to dump the garbage
Social Costs: Collection cost,
environmental damage cost, health threat.
Recycling cost: Collection cost to recycle
Deposit Refund System
2.7 Environmental Performance Bonds
This instrument is the same as Deposit Refund System but
resource extracting companies are subject to deposit a certain
fund or valuable assets.
Objective: Companies need to take adequate measures to
minimize the environmental damage caused by their activities
They effect clean up and restoration of residual damage in the
most cost effective manner
Adequate fund are available for the clean up of waste and
restoration of damaged environments by anyone who fails to
comply
Environmental bonds need not be a constrain on economic
activity, as they can be invested in interest bearing accounts
or replaced by bank guarantees.
Environment Performance Bonds
Question
A comparison 3 economic instruments:
Emissions Charges and Deposit-Refund
System and Deposit from producer?
 Incentive to improve waste control technology

Cost MAC0 :0riginal

AB cost: G + H
TAX: D + E + F
MAC1 MAC0 Total : DEFGH

MAC1: New
Total D + E + H
Cost saving: F + G

Tk F
G
D E H

Wk =1000 Wm =1500
400

Emission
Exercise 1
A paper company (MNPB = 4 - q) is operating next to a river, dumping
harmful chemicals into it. As a result, the soft drink factory operating
further down the river is suffering losses (MEC = 1/3 q) because of
the incerased water purification costs.
 a)If the government now passes a law that everybody has the right for
a clean environment, how much would the paper company have to pay
(minimum and maximum) to the soft drink company in order to be
allowed to continue operation? What will be the output of the paper
company at the end of the bargaining process? Please make a drawing
showing the situation!

b) If the government would like to ensure the pollution reduction using a

norm or a tax, which instrument should it choose and why? (Taking
into account that the goverment does not know exactly the MNPB
curve of the paper company) (You do not need to draw or make any
calculations here!)
Exercise 2
The profit curve of a steel plant is MNPB=9-q, the
associated environmental pollution causes social
costs in the order of MEC=1/2q. The authority tries to
estimate the company’s profit curve and arrives at the
following result: MNPB’=6-q.
a) If the government decides to regulate using a
norm, where will it set the norm, and what will be
loss caused by the mistake?
b) If the government decides to regulate using a tax,
where will it set the tax, and what will be loss caused
by the mistake?

Exercise 3
Two large factories are operating in the same area, causing serious SO2-emissions
(70 and 40 units). The authorities would like to reduce the emissions of SO 2
to 60 units using a tax. The total abatement cost curves of the factories are:

TAC1=2q12 TAC2=3q22
(where q means the amount of removed pollution).

a) How many units of pollution will each company remove and what is the tax
rate necessary to achieve this? What will be the cost of this policy solution for
the companies?

b) What will happen if another factory starts operation in the same area? (Please
describe the nature of the effect on the two existing factories, the authorities
and the environment!)
And what is the effect of a new entry if there is an emissions trading system
instead of a tax?
Exercise 4
The marginal abatement cost curves of two
companies are the folowing: MAC1 = 5q1;
MAC2 = 4q2 (where q means the amount of
removed emissions). The companies are
regulated by a tax, and the revenue of the
authorities from the two companies is 880
and 1200. The total cost of the regulation
for the two companies is 1040 and 1400.
What were their original emissions?
Exercise 5:
Three coal power plants are operating in the same area, causing serious SO 2-emissions (40, 60 and 20 units).
In order to protect the health of the local population, the authority would like to bring down the total
emissions of SO2 to 60 units. The marginal abatement cost curves of the power plants are:

MAC1=2q1 MAC2=2q2 and MAC3=5q3

(where q means the amount of pollution removed by the company).

The authority is considering two instruments to achieve the desired goal:

a) Setting a norm requiring equal remaining emissions.

b) Introducing an emissions trading system, where the SO2 permits are auctioned to the companies (they do
not get any for free).
 Questions:

 How many units of pollution will each company remove in the two situations?

 In situation a), how high does the penalty at least have to be in order to ensure that all three power
plants comply with the norm?

 In situation b), what will be the permit price?
Exercise 6
Two companies’ pollution abatement costs
can be described by the following curves:
MAC1=30q1 MAC2=20q2. Their original
emissions are 54 and 40 units. The
authorities would like to reduce the total
pollution by 30 units, and they do this by
issuing tradable permits, which are equally
distributed between the two companies.
How many permits will change hands
between the companies and at what price?