Chapter 16 (Part Two): Incentive-Based Regulations Flashcards
How does IB relate to perfect information?
Theory in IB systems based upon assumption of perfect information
- Regulators assume know everything about benefits and costs of pollution control
- Real world pratice of regulation this assumption is far from the truth
What are the special cases in IB regulation?
Special Cases in IB Regulation:
- Steep Marginal Benefit
- Steep Marginal Costs
How does extreme cases in the IB regulation influence efficiency (tax) loss?
What happens when the marginal benefit benefit curve is steep?
- regulators want to keep tight control over actual quantity of pollutant release
- Ensure threshold not far exceeded
Then, marketable permit system preferred to pollution tax (because costs being wrong)
Case 01: Permits Preferred
Case 02: Taxes Preferred
When are permits preferred when marginal benefit benefit curve is steep?
Illustrates pollutant with a safety threshold:
- Cleanup need not be pursued beyond C’ since additional benefits lower
- Cleanup levels below C’ - damages from additional pollution begin mount steeply
When are taxes preferred when marginal benefit benefit curve is steep?
Costs sensitive to level of cleanup
- Pollution reduction to level of C’’ can be pursued relatively cheap
- Beyond C’’ - costs mount rapidly
Tax preferred when: social costs being wrong arise more from increased compliance costs and less from the benefits of reduction
How can the steep marginal benefit benefit curve be applied to greenhouse gas emissions?
Implementing a Kyoto-like Treaty:
- National level: each country issue annual permits to greenhouse gas polluters are treable within country up to Kyoto level emissions
- If prices rise above target level - governments government should sell additional annual permits at that price
- Puts price ceiling on permit prices at government selling price
Advantages:
- Marginal cost reduction low then Kyoto targets achieved
- If marginal reduction costs high → economy avoids an expensive crash reduction in greenhouse emissions
Incentive-Compatible Regulation
What is the incentive to lie?
- Incentive-based reguations ensure that incentive faced by the regulated parties are compatible with the goal of the regulator
Firms expecting marketable permit system - have incentive to overstate compliance costs
If firms expect a tax - incentive exists to understate compliance costs
Incentive-Compatible Regulation
How to determine pollution control:
p = industry pollution level, L = number of permits made avaible, z = price permit, e = subsidy level for emission reductions
- Industry’s total pollution control costs are thus
- Cleanup costs + permit costs - excess emission reduction subsidy
- Area under MC curve + zL - e(L-p)
Incentive-Compatible Regulation
What is the incentive to tell the truth
If firms overstate their costs …
If firms overstate their costs …
- Large supply of permits not cause price to fall - unlike in marketable permit system
- Instead, high emission subsidy cause permit price firms have to pay to be driven up
- Long as e is greater that the price of permits, each firm be better buying another permit, holding emissions constant and collecting subsidy for the extra “reduction”
- Firms lose money not reduce pollution and recieve subsidy so they cut back on pollution
Example of incentive compatible approach works in follow way:
- Regulators tell firms combine auction of marketable permits with subsidy payments for any pollution reduced above number of permits firm holds(excess emission reduction subsidy)
Incentive-Compatible Regulation:
What is the incentive to tell the truth
If firms understate their costs:
- True marginal costs of reduction will exceed the subsidy for excess emission reduction
- Firms pollute to the limit L and not take any subsidies
- This stricter and more costly standard they would have faced if they had told the truth
