ECON 3755: Environmental Economics Economics of Pollution Reading: Field and Olewiler (2005): Chapter 5.

Recall our analysis of competitive market failure: So, we have focused on the demand and supply of a polluting good to explain the problems associated with pollution. We identified marginal external costs (MEC) as the problem We said that when a negative pollution externality exists in a competitive economy, the MEC create a market failure: Too much of a polluting good is produced A dead weight loss (DWL) to society is created The equilibrium is not socially efficient Net social value is not maximized

 Production Externality: when the production of a good produces a pollutant, and costs imposed on individuals in society (health/noise/sight/etc) are not considered in the private market exchange Net Social Value:
MSC At QC: Total Social Benefit = D+E+F+G+H Total Cost = G+H+I Net Social Value = D+E+F-I So, I represents the Dead Weight Loss from producing above Q*.

P, MWTP, MSC

MSC

D Private S E I H F G

PC =MWTP

Private D=MWTP Q* QC

Quantity (Q)

 Consumption Externality: when the consumption of a good produces a pollutant, and costs imposed on individuals in society (health/noise/sight/etc) are not considered in the private market exchange
P, MWTP, MSC
Private S=MSC

Net Social Value:

At QC: Total Social Benefit = D+E+F+G+H Total Cost = G+H+I Net Social Value = D+E+F-I

PC =MSC

D
E I

H
MWTP F G

Private D

So, I represents the Dead Weight Loss from producing above Q*.

MWTP
Q* QC

Quantity (Q)

To analyse pollution problems more precisely, we will now focus on actual levels of pollution: Examine the damages they impose Consider the benefits and costs of reducing them to target levels

Economics of Pollution Model: (i) The Marginal Damage (MD) Curve We know that as more goods are produced and consumed in the private market, marginal external costs (MEC) increase We can analyze the MEC directly by relating different levels of a pollutant with their associated marginal damages imposed on society A Damage Function relates the quantity of a pollutant (i.e. emissions or ambient concentrations) to the value of its damages.
Total Damage Total Damage Curve Total

Example:

Damage

CO2 emissions

A marginal damage (MD) curve shows the change in damages from a unit increase in the pollutant. Total damages are represented by the area under the MD curve up to the quantity of the pollutant produced.
Total $ Damage A

Total Damage (TD)

If the Total Damage Curve is linear, then the Marginal Damage Curve is horizontal

Example:
CO2 emissions

$/CO2

At X:

Total Damages =A Total damages (TD) are represented by the Marginal area under the MD Damage (MD) curve up to the quantity of the pollutant produced (area A)

CO2 emissions

o Typically, we assume an exponentially increasing Total Damage Curve, so the Marginal Damage Curve is upward sloping.
Total Damage $

Total TD Damage

Example:
$

CO2 emissions
MD

$MD A CO2 emissions

(ii) The Marginal Abatement Cost (MAC) Curve: We know producers/consumers will produce/consume goods until their private marginal cost = private marginal benefit If there is no cost for pollution in a competitive economy, polluters will have no incentive to consider external costs Therefore, pollution reduction costs, or abatement costs, will be zero i.e. Polluters will produce a competitive level of pollution (PollC), and there will be no pollution abatement effort If polluters reduced pollution (to say Poll1<PollC), they would accumulate abatement costs. Total Total $ Total Damage Abatement
Costs

Abatement Cost Curve (TAC)

Poll1

PollC

CO2 emissions

A marginal abatement cost (MAC) curve shows the change in abatement cost from a unit decrease in the pollutant. Total abatement costs are represented by the area under the MAC based on the quantity of the pollutant reduced.
Total $ Abatement Costs Total Abatement Cost Curve (TAC)

Total If the Total Abatement cost Damage curve is linear, then the
Marginal Abatement Cost curve is horizontal

Example:

$/CO2

Poll1

Total abatement costs (TAC) are represented by the area under the C CO2 emissions MAC curve from Poll At X: the initial Marginal Total Damages =A competitive market Abatement level of pollution, Marginal Cost Curve PollC, to the Damage (MAC) (MD) reduced level, Poll1 (area B) CO2 emissions

o Typically, we assume an exponentially increasing Total Abatement Cost Curve, so the Marginal Abatement Cost Curve is downward sloping.

Total $ Abatement Costs

TAC Total Abatement Cost Curve (TAC)

Total Damage

Example:

MAC Poll MAC

C Poll CO 2 emissions

$MAC

Poll1

PollC

(iii) The Socially Efficient Level of Pollution: A Socially Efficient level of pollution is one that minimizes the Total Social Costs imposed on society Total Social Costs = Total Damages + Total Abatement Costs Total social costs will be minimized when the marginal damages of pollution equal the marginal costs of pollution abatement In the MAC/MD Framework, a Socially Efficient level of pollution is one that sets: MAC = MD
$ MAC MD At Poll*: Total Damages = A Total Abatement Costs = B Total Social Costs (TSC*) = A+B

MAC=MD A B

In-class exercise: Prove that Poll* minimizes total social costs

Pollution

Poll*

(iv) The Competitive Market Level of Pollution:

Recall, polluters will set MAC = 0 in a competitive market

$ MAC MD

MAC=MD A Poll* B

At PollC: Total Damages = A+B+C Total Abatement Costs = 0 TSCC = A+B+C Since TSC* = A+B, the DWLC = C

PollC Pollution

Any small reduction in pollution from PollC will reduce total social costs, reduce DWL, and bring society closer to the socially efficient level of pollution However, setting Poll = 0 may not be better for society than PollC Here, we would need to estimate the TSC under each scenario and compare

Comparing the Demand/Supply vs. MAC/MD Frameworks: (production externality)

$/unit MSC MSCC

MWTP* = MSC*

I Private S

PC =MWTPC Private D=MWTP Q* $/unit QC MD Quantity (Q)

MDC

MAC

MAC*=MD* A MACC Poll* B

PollC

Pollution (Poll)