Lecture 2: Policy Instruments I

Question 1

Give examples for important (economic) selection criteria

Answer 1

• Effectiveness: is the policy goal reached?
• Efficiency/cost-effectiveness: goal achieved at lowest cost?
• Equity/fairness: do strongest shoulders carry heaviest burden?
• Cost recovery: e.g. tax + vs. subsidy
• Administrative complexity: e.g. transaction costs
• Enforceability: e.g. monitoring, legal issues
• Polluter pays: e.g. strong lobby prevents it?

• Indirect effects: e.g. employment
• Feasibility: compatible with institutional/regulatory
• Acceptability: e.g. public opinion, private sector
• Other? (e.g. contextual, common sense, etc.)

Question 2

Name the 4 different types of policy instruments

Answer 2

1. Command and Control (Emission standards, production/technology standards, product standards, bans/quotas)
2. Communication (Certification, labelling, Education, moral suasion, voluntary action)
3. Economic (market-based) (Taxes, subsidies, tradable permits)
4. Other instruments (Government procurement, negotiation, community based management)

Question 3

What are benefits of labelling?

Answer 3

• Informing consumer choice - empowers people to discriminate between products
• Promoting economic efficiency - need for regulation is kept to minimum
• Stimulating market development - signal guides the greening of markets
• Encouraging continuous improvement - long term commitment of companies
• Encourages: monitoring - judge validity of a claim

Question 4

What are challenges of labelling?

Answer 4

• Misleading or fraudulent claims - distrust of consumers
• Unfair competition - especially when claim is false
• Feasibility - not relevant/useful for all products/markets (mostly end-products/consumers)
• Methodologies > differences in testing and certification methods (label jungle’)

Question 5

What are command and control instruments?

Answer 5

Command and control regulations focus on preventing environmental problems by specifying how a company or sector will manage a pollution (externality)-generating process imposing detailed regulation

1. Emission standards (e.g. standard on air pollution of waste incinerators)
2. Production/technology standards (e.g. require to use best available technology)
3. Product standards (e.g. light bulb)
4. Bans & restrictions (e.g. trade)
5. Quota, caps, permits (e.g. fisheries)

Question 6

Why is command and control (in isolation) economically inefficient?

Answer 6

• Mitigation costs may vary across firms —> for efficiency, firms that have lower mitigation costs should mitigate more
• No incentives to reduce emissions below standard

Still, C&C regulation may be desirable when:
• Firms/sectors/households have similar MMC functions
• There are emergencies or the optimal level of pollution is at or near zero (i.e. efficiency is not a priority, but effectiveness is)

Question 7

What is the Pigouvian tax?

Answer 7

Socially optimal tax in case of externalities: when tax is Pigouvian - tax is equal to the marginal external costs in the social welfare optimum (Pigou 1920, The Economics of Welfare)

pigouvian (pollution) tax = a per-unit tax set equal to the external damage caused by an activity, such as a tax per ton of pollution emitted equal to the external damage of a ton of pollution.

Question 8

What are the functions of taxes?

Answer 8

1. Allocative/regulating: focus on changing behavior affecting e.g. choice between abatement of pollution and paying tax
   Pigou: ‘Getting the prices right’ (internalizing externalities)
   Reduce marginal damages: tax = marginal external costs
2. Revenue raising: important source of income for the government (don’t want to change behavior too much).
   Ramsey: ‘Raising revenue on least elastic products’ (assuming no externalities!)
   Minimize distortion (minimize dead weight loss)