ch 15: incentive-based regulation (theory)

Question 1

benefits of incentive based regulation

Answer 1

1. Lower the short-run costs of pollution control
2. Provides better incentives for long run technological improvements compared to the current CAC approach

Question 2

Command and control regulaiton

Answer 2

Government sets limits to pollution and controls to that amount.

Question 3

why does CAC regulation not work?

Answer 3

Does not work because puts a lot of responsibility on government when generally they are less well-informed than industry.

Businesses spend resources trying to get around policies and end up having unregulated emissions.

Question 4

2 types of IB regulation

Answer 4

1. pollution taxes = a price instrument
   ie pigovian taxes, emission/effluent fees
2. cap and trade systems = quantity instrument
   ie marketable or tradeable permit system

Question 5

the cost-effectiveness rule

Answer 5

Cost-effective pollution control can be acheived only when the marignal costs of reduction at each source are equal

Whenever the marginal cost of pollution reduction at one source is greater than that of another, overall costs can be reduced without changing the pollution level by decreasing pollution at the low cost site and increase it at the high cost site

difficult to mandate because of imperfect information

Question 6

giveaways vs auctions/taxes

Answer 6

giveaways = prefered by firms
- firms are costed less because only pay clean-up costs + costs of any additional permits needed
- create opportunities for firms to make money through selling excess permits or having lower clean-up costs than the rise in price of goods

auctions and taxes = preferred by economists
- firms may tax revenues + clean up costs
- double-dividend can motivate people and help ensure that incentive-based approaches are nonregressive

Question 7

double-dividend vs. cap and dividend approach to tax/auction revenues

Answer 7

1. double-dividend
   Using pollution tax (or cap and trade auction) revenues to reduce taxes on labor (or capital) would discourage pollution and encourage work (or investment)
2. cap and dividend:
   Rebate the revenues directly back on an equal basis to all citizens. Rebating revenues generally lead to net benefits for the majority of people (progressive policy)

Question 8

How does Ib regulation incentive long run technological progress?

Answer 8

taxes - less pollution means lower taxes

permits - pollution bears an opportunity cost since less pollution frees up permits for sale

–> in both cases, since pollution is now costly to firms, they have motivation to continue to seek out new ways of reducing pollution

Question 9

Potential problems w IB regulation

Answer 9

1. hot spots
   - high local concentrations of pollutants
   - occur when there is nonuniformly mixed and concentrated pollutants
   - Taxes would have to be higher (or emissions value of a permit lower) in already polluted areas
2. monitoring and compliance problems
   difficult to achieve direct monitoring of emissions and enforcement of violations
3. the need to make a sustained political commitment to emission reduction over time

Question 10

uniformly vs non-uniformly mixed pollutants

Answer 10

uniformly mixed pollutant: emissions concentrations are spread evenly over multiple areas

Nonunifrmly mixed pollutant: the bulk of the damage is done locally, but effects do drift into other areas

Question 11

how is pollution control measures decided under perfect information?

Answer 11

want to maximize benefits
When MB curve is steep
- regulators will want to keep tight control over actual quantity of polutant released to ensure the threshold is not far exceeded
- Permits system is preferred to pollution tax because of costs of being wrong

want to minimize costs of being wrong
- Flatter mc curve of being wrong –> Less clean-up pursued
- Steep Mc curve of being wrong –> More clean up pursued

When social costs of being wrong arise more from increased compliance costs and less from the benefits of reduction, a tax policy will be preferred

Question 12

Disadvantages of permits

Answer 12

1. Thin markets: markets with only a few buyers and sellers
   - trades are infrequent and prices are not easily defined –> ib systems limited by imperfect information
2. Market power
   - Existing firms will most likely have market power if new firms are forced to buy permits from direct competitors
3. Price volatility
   - fast-changing market prices can lead to program failure
4. Permit life
   - Short permit lives quickly lose value and are not worth trading
   - Firms must be able to bank their permits

Question 13

Disadvantages of taxes

Answer 13

1. higher immediate costs for firms
2. The need to increase taxes over time to account for inflation and economic growth

Question 14

In what two cases can price volatility be a problem?

Answer 14

1. when price goes unexpectedly high, it makes it difficult for firms to buy new permits so they will hang on to the ones they have. discourages market participation and the cost savings that could arise from permit sales
2. when prices unexpectedly collapse, firms incentives to invest in long run pollution reduction measures are reduced bc will be cheaper to just buy permits

Question 15

What 2 methods can be used to reduce price volatility?

Answer 15

1. banking
   If firms can carry over unused permits from year to year, then during periods of low prices, firms are likely to hold onto permits (helping increase prices) for use/sale during high-price periods (helping moderate price increases)
2. price collar: a government-set price floor combined with a government-set price ceiling
   - government buys permits when the price falls below the floor and then bids prices back up to the minimum
   - govenrment banks permits and sell them when prices rise above the ceiling to reduce prices