CHAPTER 6

Pollution control: instruments

5

10 15 35 40302520

Pollution abatement, Z

Z

MCA = 3ZA

MC

MCB = 3ZB

75

100

200

Figure 6.1 Marginal abatement cost functions for the two firms

Figure 6.2 Expected damages, reducing as the amount of precaution taken, Q, increases

Expected damages

The amount of precaution taken, Q

B(Q)

C(Q)

MB(Q)

MC(Q)

Q*

Q*

Precaution, Q

Precaution, Q

Figure 6.3

The socially efficient level of precautionary behaviour

The level of precaution applied is socially efficient when the net benefit (B – C) from precaution is maximised. This is shown at Q = Q*. Note that the slopes of the B and C functions are equalised at this point. Hence, as shown in the lower half of the graphic, the marginal quantities are equated. That is, the marginal benefit of precaution and the marginal cost of precaution are equal at the socially efficient level of precaution, Q*. That is, MB(Q*) = MC(Q*).

Location of emissions

Ambient pollution levels

Emissions output

Production technique

Inputs used

Quantity of goods produced

Figure 6.4a The pollution process

Zoning

Ambient pollution requirements

Emissions licenses

Technology controls

Input restrictions

Output quotas

Figure 6.4b Command and control instruments

Figure 6.5 An economically efficient emissions tax

0 Z* = *MM̂ Z

M̂

Emissions abatement, Z

*

Marginal benefit (before tax)

0

*

Marginal benefit (after tax)

M* Emissions, M

Marginal damage

Marginal cost of abatement

Marginal benefit of abatement

Figure 6.6 The economically efficient level of emissions abatement

M̂

Pre-tax or pre-subsidy marginal benefit

0

Emissions, M

Figure 6.7 Emissions tax and abatement subsidy schemes when marginal damage is unknown, or when a target is being set on grounds other than economic efficiency

Post-tax or post-subsidy marginal benefit

M~. .

μ~ .

Suppose that the EPA does not have sufficient information to deduce the economically efficient level of emissions, or it wishes to set an overall emissions target on some other basis. Figure 6.7 makes it clear that to attain ANY specific emissions target using a tax or subsidy instrument, knowledge of the aggregate (pre-tax or pre-subsidy) marginal benefit of emissions function would be sufficient.

M̂

Pre-tax or pre-subsidy marginal benefit

0

*

M* Emissions, M

Marginal damage

Figure 6.8 Emissions tax and abatement subsidy schemes: a comparison

S3 S4S6 S2

S1S5

Post-tax or post-subsidy marginal benefit

An emissions tax and an emissions abatement subsidy (at the same rate) differ in terms of the distribution of gains and losses. This has important implications for the political acceptability and the political feasibility of the instruments. It also could affect the long-run level of pollution abatement under some circumstances, via alteration of the size of the industry.

Figure 6.9 The determination of the market price of emissions permits

Auctioned permits case

Marginal abatement cost (aggregate)

*

M̂M* Emissions, M

0

Fixed supply of permits

A firm will bid to purchase an additional emissions permit whenever the marginal cost of abating emissions exceeds the permit price. The market equilibrium permit price is determined by the value of the aggregate marginal abatement cost at the level of abatement implied by the total number of issued permits.

Demand for permits

*

EP* Emission permits (EP)

0

Figure 6.10 The determination of the market price of emissions permits: free initial allocation case

Supply of permits

Figure 6.11: Efficient abatement with two firms and marketable permits

0

20

40

60

80

100

120

140

160

180

200

0 5 10 15 20 25 30 35 40 45 50

Emissions abatement, Z

Mar

gin

al a

bat

emen

t co

st

MC(B)

MC(A)

MC(INDUSTRY)

Required industry wide abatement

Equilibrium permit price = Marginal abatement cost for each firm = 75

Under tradable permit schemes, in equilibrium marginal abatement costs will be equal over all firms. Hence marketable permits, like taxes and subsidies, achieve any given target at least cost. Moreover, if the total quantity of permits issued is M* and that quantity is identical to the level of emissions which would emerge from an emissions tax (or an abatement subsidy) at the rate * then a marketable permit scheme will generate an equilibrium permit price *.

.4

.2

.5

.1

.6

.3

Firm 3, one of six controlled large power station sources of CO2

Controlled sector

Figure 6.12.a A ‘cap and trade’ permit system

.A .4

.2

.5

.1

.6

.3

Firm 3, one of six controlled large power station sources of CO2

Controlled sector

Figure 6.12.b A flexible permit system with offsets

Uncontrolled sectors (of other CO2 emitters)

.A

.B

.C

.D

MC1

MC2

£

0 Emissions abatement, ZZ1*

Figure 6.13 Dynamic incentives under emissions tax controls

Z2*

•

•

2*ii

*iiii MδMβαC

Ci

i

i*i M̂M 0M*

i *iM

Figure 6.14 The firm’s abatement cost function.