Chapter 31 Powerpoint

Chapter 31

Environmental Economics

Copyright ©2014 Pearson Education, Inc. All rights reserved. 31-2

Introduction

“Cap and trade” is an approach to air-pollution control under which governments place a limit on allowed emissions, create rights to emit polluting substances, and permit firms to trade those rights in a free market. A cap and trade program applied to sulfur dioxide emissions from electrical plants in the U.S. has reduced polluting emissions by one-half.

This program recently collapsed, however. What can be learned from the breakdown of this program?

You will explore this question in Chapter 31.


Learning Objectives

• Distinguish between private costs and social costs

• Understand market externalities and possible ways to correct externalities

• Explain how economists can conceptually determine the optimum quantity of pollution


Learning Objectives (cont'd)

• Contrast the roles of private and common property rights in alternative approaches to addressing the problem of pollution

• Describe how many of the world’s governments are seeking to reduce pollution by capping and controlling the use of pollution generating resources

• Discuss how the assignment of property rights may influence the fates of endangered species


Chapter Outline

• Private versus Social Costs• Correcting for Externalities• Pollution• Common Property • Reducing Humanity’s Carbon Footprint:

Restraining Pollution-Causing Activities• Wild Species, Common Property and

Tradeoffs


Did You Know That ...

• By 2025, the Environmental Protection Agency (EPA) will require all passenger vehicles to operate at an average of 54.5 miles per gallon?

• This improvement in fuel economy will translate into a 10 percent increase in the average price of a vehicle.

• Economists want to help policymakers and citizens opt for informed policies that have the maximum possible net benefits.

• As you will see, every decision made in favor of “the environment” involves a trade-off.


Private versus Social Costs

• Private Costs

– Costs borne solely by the individuals who incur them

– Also called internal costs


Private versus Social Costs (cont'd)

• Social Costs

– The full costs borne by society whenever a resource use occurs

– Measured by adding internal to external costs



• Environmental issues occur when social costs exceed private cost

• The cost of polluted air—consider both private and social costs

• Question– What if you had to pay the social cost of driving

a car?



• Externality

– A situation in which a private cost (or benefit) diverges from a social cost (or benefit)

– A situation in which the costs (or benefits) of an action are not fully borne (or gained) by the two parties engaged in a scarce-resource-using activity


Figure 31-1 Reckoning with Full Social Costs


Correcting for Externalities

• An externality arises when there is a divergence between private cost and social cost

• The remedy is to change the signal for decision making

• In the case of industrial pollution, the firm must be forced to internalize the cost of the environmental damage


Correcting for Externalities (cont'd)

• The polluters’ choice

1. Install pollution abatement equipment or change production techniques

2. Reduce pollution-causing activity

3. Pay the price to pollute


Correcting for Externalities (cont'd)

• Is a uniform tax appropriate?

– It may be appropriate to levy a uniform tax, as external costs might vary from location to location

– We must establish the amount of economic damages; we have to come up with a measure of economic costs


Pollution

• Question– How much pollution is too much?

• Answer– The optimal quantity is determined by a

comparison of marginal costs and benefits.


Pollution (cont'd)

• Optimal Quantity of Pollution

– The level of pollution for which the marginal benefit of one additional unit of pollution abatement just equals the marginal cost of that additional unit


Figure 31-2 The Optimal Quantity of Air Pollution


Policy Example: Raising the Marginal Cost of U.S. Air Pollution Abatement

• Coal-fired plants generate nearly half of all electricity produced in the United States each year.

• The Environmental Protection Agency has issued regulations that require 20 percent of these plants to shut down or be retro-fitted with scrubbers in 2015.


Policy Example: Raising the Marginal Cost of U.S. Air Pollution Abatement (cont’d)

• Estimates indicate that the additional cost to the electrical power industry and its customers of complying with this requirement will be about $30 billion per year through the end of the 2010s.

• Thus, attaining a hoped-for higher degree of air cleanliness will entail a higher marginal cost of pollution abatement for society.


Common Property

• Private Property Rights

– Exclusive rights of ownership that allow the use, transfer, and exchange of property


Common Property (cont'd)

• Common Property

– Property that is owned by everyone and therefore by no one

• Examples are air and water



• Question– What do you think: Why does pollution occur

when property rights are poorly defined?

• Answer– When no one owns a particular resource, no one

has any incentive (conscience aside) to consider misusing it.



• Voluntary agreements and transactions costs

– Is it possible for externalities to be internalized via voluntary agreement?

– What are the costs incurred by the parties who seek to negotiate an agreement?




– Voluntary agreements: contracting

– Opportunity cost always exists, whoever has property rights




– Transaction Costs

• All costs associated with making, reaching, and enforcing agreements

– Must be low relative the expected benefits



• Changing property rights

– Closing the gap between private costs and social costs

• Taxation

• Subsidization

• Regulation


Reducing Humanity’s Carbon Footprint: Restraining Pollution-Causing Activities

• Mixing government controls and market processes: cap and trade– In light of the costs arising from spillovers that

polluting activities create, one solution might seem to be for governments to try to stop them from taking place

– Why don’t more governments simply require businesses and households to cut back on pollution-causing activities?


Reducing Humanity’s Carbon Footprint: Restraining Pollution-Causing Activities (cont’d)

• Kyoto Protocol (1997) aims to reduce overall emissions of greenhouse gases by 2020 by as much as 20% below 1990 levels

• The EU’s Emissions Trading Scheme (2005)– Each EU nation is established an allowance of emissions

that a company can release– If a firm exceeds its limit, it must purchase additional

allowances (at the market clearing price) from companies who are emitting less than their quota


Policy Example: California Dreaming: A Western Cap-and-Trade Pact?

• Preceding implementation of California’s cap-and-trade program, state officials tried to persuade governments of other western states to enter into a “regional cap-and-trade pact.”

• Every state that California officials approached said no, however, as the induced reduction in the energy supply would bring about higher energy prices.


Policy Example: California Dreaming: A Western Cap-and-Trade Pact? (cont’d)

• Most estimates indicate the costs will amount to hundreds of dollars per household per year.

• Businesses will face significant cost increases as well, which may decrease employment.

• Some California firms may respond to higher energy costs by moving their operations to other western states.


International Example: Passengers Help to Pay for Emissions on EU Airline Routes

• In 2012, the European Union implemented a new, independently administered cap-and-trade program aimed at reducing carbon emissions from airplane engines.

• The EU allocated pollution total allowances to each airline operating at EU airports.

• To exceed its limit, an airline can purchase allowances from another airline that has total emissions below its allowances.


Reducing Humanity’s Carbon Footprint: Restraining Pollution-Causing Activities (cont'd)

• Are there alternatives to pollution-causing resource use?

– Why aren’t we shifting to solar panels and electric cars?

– The plain fact is that the cost of generating solar power in many circumstances is much higher than generating that same power through conventional means

– In addition, the manufacturing of solar panels could itself cause pollution


Wild Species, Common Property, and Trade-Offs

• One of the most distressing common property problems involves endangered species

• Virtually all species not endangered are private property (dogs, cats, cattle, sheep and horses)

• Endangered species (spotted owls, bighorn sheep and condors) are typically common property


Wild Species, Common Property, and Trade-Offs (cont'd)

• In 1973, the federal government passed the Endangered Species Act in an attempt to keep species from dying out

• As more and more species were put on the endangered list, a trade-off became apparent


What If . . . Governments allowed people to own endangered animals as private property?

• If endangered animals could be owned as private property, some of them undoubtedly would be mishandled.

• Nevertheless, they are also scarce resources that have positive values in private markets.

• This would provide incentives for the life of these animals and health of the species to be preserved.


You Are There: A Mayor Faces the Grimy Economics of Trash Removal

• For Chicago mayor Rahm Emanuel, how to go about moving trash for disposal or recycling has become a substantial economic issue.

• Currently, the trash removal system in Chicago is different for each one of the city’s 50 wards.

• Emanuel examines a study that proposes a reorganization of the city’s trash removal procedures. The study suggests that switching to a more efficient citywide system for trash disposal and recycling could accomplish the same task each year with 25 percent fewer workers and at an annual cost savings of $40 million.


Issues & Applications: The New Sulfur Dioxide “Cap and Fade” Program

• For years, coal-fired electrical-power-generating plants in Midwestern states emitted smoke containing sulfur dioxide. These emissions have contributed to a phenomenon known as “acid rain”.

• In 1995, the U.S. government placed a cap on emissions of sulfur dioxide states.

• A fixed number of emission allowances were handed out to the electric utilities. If firms reduced emissions by switching to low-sulfur coals or by adding emission-control equipment, they could sell unused allowances to other electrical-power producers.


Issues & Applications: The New Sulfur Dioxide “Cap and Fade” Program

• By 2005, the equilibrium price of a sulfur-dioxide-emission allowance had reached $1,600. This price was sufficiently high to induce many firms to reduce their emissions.

• In 2008, however, the EPA began ordering plant operators to cut back directly on their emissions. The EPA also decided not to allow firms to purchase allowances to avoid the new emissions restrictions.

• Since then, the equilibrium price of a sulfur dioxide-emission allowance has “faded away” to zero—hence the new “cap and fade” term used to describe the program.


Summary Discussion of Learning Objectives

• Private costs versus social costs– Private costs are borne solely by those who use

resources

– Social costs are the full costs that society bears when resources are used

• Market externalities and ways to correct externalities– Tax those who create externalities


Summary Discussion of Learning Objectives (cont'd)

• Determining the optimal amount of pollution– The level of pollution at which the marginal benefit of

pollution abatement equals the marginal cost of pollution abatement

• Private and common property rights and the pollution problem– Private property rights permit exchange and use of a

resource

– Common property is owned by everyone and thus by no one



• Restraining pollution-causing activities through caps and allowances– The EU has established the Emissions Trading

Scheme– Each EU nation’s government establishes an

overall target level of greenhouse gas emissions and distributes allowances, granting companies the right to emit a certain amount of gases

– If exceeded, the company must purchase more allowances from firms emitting less than their quota



• Endangered species and the assignment of property rights

– Animals that are privately owned (e.g., dogs and livestock are abundant)

• Owners have incentives to take care of these animals

– Wild animals are common property resources and many are endangered because no one has an incentive to protect these animals