Environmental Economics

1. Environmental Economics

10. Cost of Reducing Pollution Total abatement Costs =Area A $ MACa Ca A Pa Greater Abatement Pollution Reduction

11. Command and control • Legislate emission levels • All firms required to reduce pollution to specific levels • ef is maximum pollution • Forced to cut in half (0.5ef) • What are costs of abatement?

12. Firm 1 Firm 2 $ (High cost firm) $ MAC2 C2 (Low cost firm) MAC1 C1 (0,ef) (ef,0) .5ef Total abatement for firm 2 Total abatement for firm 1 Abatement

13. Firm 2 Firm 1 Total abatement Costs = a+d+f+b+g $ $ C2 d Ce f C1 a b g .5ef Abatement

14. Taxes • Instead of command and control, why not tax emission • Requires continuous monitoring • In this case, Ce is per unit tax • Two characteristics • Equal cost at the margin for both firms • Will show it holds total pollution constant to command and control levels

15. Firm 2 Firm 1 Total abatement Costs = a+d+f+b+g $ $ C2 d Ce f C1 a b g .5ef Abatement

16. Firm 2 Firm 1 Total abatement Costs = a+b+g $ $ Total cost savings=d+f C2 d Ce Ce f C1 a b g .5ef e1 Taxes paid, Firm 2 Taxes paid, Firm 1 Abatement

17. Firm 2 Firm 1 $ $ C2 d Ce Ce f C1 a b g .5ef Abatement

18. Firm 2 Firm 1 $ $ C2 d Ce Ce f C1 a b g e1 .5ef Abatement

19. Cap and trade • Start with command and control levels • Receive permit to pollute 0.5ef • must abate 0.5ef • However, you can increase pollution levels only if you purchase the right to pollute from another manufacturer • Who would sell their right to pollute? Who would purchase?

20. Firm 2 Firm 1 $ $ C2 d Ce Ce f C1 a b g .5ef e1 Abatement

21. Firm 2 Firm 1 $ $ C2 d Ce Ce f C1 a b g e1 .5ef Abatement

22. Firm 2 • Willing to pay area d+f+b for the right to pollute more • Firm 1 • Needs b to increase pollution • Trade will take place • Notice that both firms are better off • Costs of a abatement have fallen by d+f