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Economics of the EnvironmentEconomics of the Environment
1. The economics of pollution1. The economics of pollution
2. Valuation of externalities2. Valuation of externalities
3. The optimal level of pollution3. The optimal level of pollution
4. Methods of pollution control4. Methods of pollution control
5. EU & UK policy5. EU & UK policy
BackgroundBackground
Pollution Pollution chemical wastes - riverschemical wastes - rivers noise pollutionnoise pollution thermal pollutionthermal pollution carbon emissions - air carbon emissions - air
industrial useindustrial use road usersroad users Table 1Table 1
Fig 1 The interaction between the Fig 1 The interaction between the economy & environmenteconomy & environment
WastesWastes
Environmentalsystem
Productionsystem
Consumptionsystem
Reclaimedmaterials
1. The economics of pollution1. The economics of pollution Negative externalityNegative externality
spillover effect of consumption\ spillover effect of consumption\ productionproduction
third party is effected - social coststhird party is effected - social costs Price mechanism?Price mechanism?
e.g. air is freee.g. air is free e.g. water - very low pricee.g. water - very low price
Over-consumption Over-consumption consumers\business - private costsconsumers\business - private costs society - social costssociety - social costs
Economics of pollutionEconomics of pollution
Private costs Private costs social costs social costs Policy objective Policy objective
change consumers\business behaviourchange consumers\business behaviour pay full social costspay full social costs
internalise the externality to reduce internalise the externality to reduce pollutionpollution
PoliciesPolicies standards, taxes, permitsstandards, taxes, permits … … valuation of a negative externalityvaluation of a negative externality
2. Valuation: A case study2. Valuation: A case study
Road traffic congestionRoad traffic congestion Road use increased dramaticallyRoad use increased dramatically
private (…and freight)private (…and freight) Policy - how to ration a scarce Policy - how to ration a scarce
resource? resource? Road use generates several Road use generates several
externalitiesexternalities e.g. Global warming, e.g. Air pollutione.g. Global warming, e.g. Air pollution e.g.Congestione.g.Congestion
How big are these social costs?How big are these social costs?
Valuation methodsValuation methods
1. Direct Approaches1. Direct Approaches Contingent valuation methodsContingent valuation methods
questionnaire & surveyquestionnaire & survey WTP or WTACWTP or WTAC value of externality = mean WTP or WTACvalue of externality = mean WTP or WTAC
2. Indirect Methods2. Indirect Methods e.g. Hedonic pricing model e.g. house e.g. Hedonic pricing model e.g. house
prices, lifetime wagesprices, lifetime wages e.g.Total economic value = use value e.g.Total economic value = use value
+ option value + existence value+ option value + existence value
Valuation of road transport Valuation of road transport externalities, 1993externalities, 1993
Externality & cost Externality & cost (£billions)(£billions) Global warming Global warming = = 0.10.1 Air pollutionAir pollution == 19.719.7 NoiseNoise == 2.6-3.12.6-3.1 Road damage Road damage == 1.51.5 AccidentsAccidents == 2.9-9.42.9-9.4 CongestionCongestion == 19.119.1 TOTALTOTAL == 45.9-52.945.9-52.9
Revenue from road use = £16.4bRevenue from road use = £16.4b
Policies to correct road transport Policies to correct road transport externalitesexternalites
Marginal road user pays about a third Marginal road user pays about a third of true cost of a journeyof true cost of a journey
Government interventionGovernment intervention build more roads - no!build more roads - no! improve public transport - yesimprove public transport - yes tax - yestax - yes road pricing - yesroad pricing - yes
Taxes & pricing depend crucially on Taxes & pricing depend crucially on value of externalities value of externalities
3. The optimal level of pollution3. The optimal level of pollution
How much pollution should How much pollution should Government tolerate?Government tolerate?
NotNot zero pollution. Why? zero pollution. Why? ……because pollution increases with because pollution increases with
outputoutput ……growth of output increases welfare growth of output increases welfare
3. The optimal level of pollution3. The optimal level of pollution
Quantity of pollution is positively Quantity of pollution is positively related to outputrelated to output
Social costs increase with outputSocial costs increase with output But, the costs of clean-up rise as But, the costs of clean-up rise as
pollution fallspollution falls What is the socially optimal level of What is the socially optimal level of
pollution?pollution? See Figure 2 See Figure 2
Fig 2: The optimal level of Fig 2: The optimal level of pollutionpollution
Costs ofpollution
Quantity ofpollution
Social costs
C2C1
Q2Q1
More untreatedwaste, the higherthe social cost
0
If pollution= 0,output would fall. Welfare?
Fig 2: The optimal level of Fig 2: The optimal level of pollutionpollution
Costs ofpollutioncontrol
Quantity ofpollution
C2C1
0 Q2 Q1
AB
Costs of pollutioncontrol at each level ofdischarge
Costs ofclean-uprise
Fig 2: The optimal level of Fig 2: The optimal level of pollutionpollution
Costs
Quantity ofpollution
0
Pollution control costs
Social costs
R
Assume thatindustry output isfixed
X Y
The optimal level of pollutionThe optimal level of pollution
Thinking marginally, optimality isThinking marginally, optimality is “…“…the cost of an extra unit of pollution the cost of an extra unit of pollution
is just equal to the cost of reducing is just equal to the cost of reducing pollution by an extra unit.”pollution by an extra unit.”
Point ‘R’ on figure 2Point ‘R’ on figure 2 pollution is not zero!pollution is not zero!
How can Government achieve this? How can Government achieve this?
4. Methods of pollution control4. Methods of pollution control
No incentive for business & No incentive for business & consumersconsumers
Government should correct the Government should correct the market failuremarket failure
MethodsMethods (a) standards & regulations(a) standards & regulations (b) Pollution tax(b) Pollution tax (c) Tradeable permits(c) Tradeable permits
4. Methods of pollution control4. Methods of pollution control
(a) Standards & regulations(a) Standards & regulations Traditional approachTraditional approach Set emissions targetSet emissions target
if targets are too strict - point Xif targets are too strict - point X if targets are too lenient - point Yif targets are too lenient - point Y correct targets - point R correct targets - point R
Penalties if business is caught in Penalties if business is caught in violation of targetviolation of target
(a) Standards & regulations(a) Standards & regulations
DisadvantagesDisadvantages (i) Costly(i) Costly (ii) Information requirements(ii) Information requirements (iii) Vague & imprecise(iii) Vague & imprecise (iv) If fines are low, no incentive to comply(iv) If fines are low, no incentive to comply (v) Conflict of standards(v) Conflict of standards
Advantages Advantages (i) If all businesses comply - very effective(i) If all businesses comply - very effective (ii) No alternative in some cases(ii) No alternative in some cases
(b) Pollution tax(b) Pollution tax
E.g. fuel tax, effluent taxesE.g. fuel tax, effluent taxes Tax is a fee consumers\producers payTax is a fee consumers\producers pay Control via priceControl via price Tax per unit of outputTax per unit of output Cleaner production process - lower taxCleaner production process - lower tax See Figure 3See Figure 3
Fig 3: The pollution taxFig 3: The pollution tax
Output
Quantity of pollution
Costs,Revenue
D = MSB
S = MPC
Qp
Y
Pp
MSC
Qr
Pr
R
MPC + tax
Pt
(b) Pollution taxes(b) Pollution taxes
AdvantagesAdvantages (i) Cheaper than standards(i) Cheaper than standards
reduce discharge: clean-up cost = pollution reduce discharge: clean-up cost = pollution taxtax
(ii) Less information required(ii) Less information required meters & chargesmeters & charges
(iii) (iii) Polluter Pays PrinciplePolluter Pays Principle price environmental servicesprice environmental services sustainable developmentsustainable development
AdvantagesAdvantages (iv) Raises revenue(iv) Raises revenue (v) Widespread compliance(v) Widespread compliance (vi) Market-based approach(vi) Market-based approach (vii) Producer & consumer share the (vii) Producer & consumer share the
costcost DisadvantagesDisadvantages
(i) Valuation? Tax rate?(i) Valuation? Tax rate? (ii) Absence of market failure e.g. (ii) Absence of market failure e.g.
monopolymonopoly (iii) Assumes Government knows the (iii) Assumes Government knows the
firms costsfirms costs
(c) Transferable pollution (c) Transferable pollution permitspermits
Second-hand market in pollutionSecond-hand market in pollution Regulator sets pollution targetRegulator sets pollution target Issue pollution permitIssue pollution permit
license to pollute to a certain levellicense to pollute to a certain level e.g. emissions e.g. emissions
Firms buy & sell permitsFirms buy & sell permits Firms have a choiceFirms have a choice
incur the cost of clean-upincur the cost of clean-up buy a permit & continue pollutingbuy a permit & continue polluting
(c) Permits(c) Permits
High clean-up costs - buy permitsHigh clean-up costs - buy permits
OutcomeOutcome
Some pollution is allowedSome pollution is allowed Remaining pollution is cleaned up at low Remaining pollution is cleaned up at low
costcost Control pollution - quantityControl pollution - quantity
(c) Permits(c) Permits
AdvantagesAdvantages (I) Market-based approach(I) Market-based approach (ii) Low cost(ii) Low cost (iii) Flexible - regular can buy permits(iii) Flexible - regular can buy permits
DisadvantagesDisadvantages (I) Valuation? Number of permits(I) Valuation? Number of permits (ii) Initial allocation is important(ii) Initial allocation is important
5. EU & UK policy5. EU & UK policy
Traditional approach - set standardsTraditional approach - set standards EU sets standards onEU sets standards on
quality of water - bathing, drinking, quality of water - bathing, drinking, emissionsemissions
waste management - sewage, toxic waste management - sewage, toxic substancessubstances
atmospheric pollution - agreed to reduce atmospheric pollution - agreed to reduce COCO22 emissions by 2012 (8%) emissions by 2012 (8%)
EU reduction targets for EU reduction targets for greenhouse gases (% change)greenhouse gases (% change)
-30
-20
-10
0
10
20
30
40
Country
Belgium
Denmark
Germany
Greece
Spain
France
Ireland
Italy
Luxembourg
Netherlands
Austria
Portugal
Finland
5. EU policy5. EU policy
How will this be achieved?How will this be achieved? ‘…‘…markets [will] be harnessed to markets [will] be harnessed to
generate the most efficient method of generate the most efficient method of achieving desired pollution reuctions.’achieving desired pollution reuctions.’
Government set targetsGovernment set targets Taxes & permits used to find the best Taxes & permits used to find the best
method method