Lecture 4 Environmental Policy

Question 1

What is the difference between flow and stock pollutants?

Answer 1

Flow-damage pollution: pollutant does not accumulate and there is no stock effect (eg. Organic Waste in Rivers)

Stock-damage pollution: pollutant accumulate and damage is dependent on the stock level (eg. Carbon Dioxide (CO₂))

Question 2

When are net benefits maximised?

Answer 2

Marginal benefits = marginal cost
At the efficient output level X* the total benefit and total cost curves are parallel to one another
The net benefit function is horizontal at the efficient output level.
Optimal pollution price is where net benefits are maximized and is referred to as the shadow price

Question 3

Explain what is an efficient level of pollution

Answer 3

Pollution has some benefits, it is unavoidable for the given technology, and can be tolerated up to a certain amount.

Efficient pollution level is the one that maximizes:
Net Benefits = Benefits - Damage

Question 4

Setting targets when marginal health damage is a rising and continuous function of emissions

Answer 4

A trade-off now exists in which lower health risks can be obtained at the cost of some loss of pollution benefits.
A ‘modified efficiency target’ would correspond to emissions level M*.

Question 5

Setting targets according to an absolute health criterion

Answer 5

Total (and marginal) health risks are zero below the threshold, but at the threshold itself risks to human health become intolerably large.
The value of marginal benefits is irrelevant in this case.

Question 6

Know and assess different types of public policy (5 Types with examples)

Answer 6

1. Campaign: Attempt to influence the behaviour of individuals, without creating mandatory rules.
2. Direct production of environmental quality. E.g. Creation of nature reserves, waste water treatment, aeration of lakes to compensate for lack of oxygen
3. Prevention of pollution
   o The government can help enhance the technologies which are the source of the pollution to make them more ecologically friendly and more profitable.

o Cooperation of Universities and private sector to develop environmentally sound technologies.

o Scholarships and aid money for environmental research and
projects.

4. Command and Control regulation means setting standards.

o A standard requires a company to make an effort that is regulated by law

o A standard would make excessive pollution illegal
o The government should try to set the optimal level of pollution control.

5. Economic incentives are set so that individual optimisation

leads to the same result as social optimisation: (1) tradable pollution certificates, (2) pollution tax, (3) pollution abatement subsidies

Question 7

Examples (types) of command and control instruments

Answer 7

Ambient pollution standards: Regulates the quantity of matter in the ambient environment
Emission standards: Regulates the level of permitted emissions.
Technology standards: require a certain technology, a certain practice or a production process.

Question 8

When are command and control instruments useful?

Answer 8

1. Monitoring costs are high.
2. The optimal level of emissions is 0 or close to 0.
3. In the case of random events and emergencies, which change the emission-damage ratio.
   Reliability of the control instruments

Question 9

Explain the differences between taxes and permits

Answer 9

Taxes determine the price of pollution
Certificates determine the amount of pollution

Question 10

Economic incentives are usually superior to command-and-control instruments because…

Answer 10

1. They minimise the social abatement costs by balancing marginal abatement costs of different producers.
2. Incentives are created to do more research and development to abate environmental damage and to create alternatives to polluting activities.

However: monitoring, administration and enforcement costs have not been considered.

Given perfect information, taxation of emissions and tradable permits produce identical results.

Question 11

Analysis of command and control instruments

Answer 11

· Determination of standards: On which level should the standards be fixed?

· Consistency of standards: Should the same standards be applied everywhere or should they vary regionally?

· Incentive for innovation: Command and control-regulations create little incentive for innovation. Once the company has reached the standard emission, there is no stimulus for further innovation.

· Enforcement: Technical standards can be easier to control than emission levels.

· Cost minimisation: If different businesses have different abatement costs, command and control instruments result in different marginal costs for different businesses and do not minimise the total social abatement costs.

Question 12

Economic incentive: Emission-taxes

Answer 12

Emission-taxes work by modifying relative prices. They can be imposed on the level of inputs or on the level of pollution.
· Subsidies can be modelled accordingly.
· Businesses will reduce pollution until the marginal abatement costs are equal to the tax rate. This results in the minimisation of total abatement costs.

Question 13

Economic incentive: Tradable pollution permits

Answer 13

The introduction of tradable pollution permits needs:
· A decision concerning the permitted total pollution quantity.
· A regulation prohibiting businesses from emitting more pollutants than allowed by the permits.
· A regulation determining how the total amount of permits is to be distributed.
· A guarantee that the permit can be traded freely between the businesses.

Question 14

Under certain circumstances it is possible to reach environmental goals for free or at “negative costs”. Reasons:

Answer 14

· Elimination of technical/economic inefficiency in the energy producing / using sector.
· Trigger for technological change.
· Double dividend.
· Positive side effects (co-benefits)

Question 15

Double dividend

Answer 15

Revenues from an emissions tax could be designed to reduce marginal rates of other taxes in the economy.
If those other taxes have distortionary (i.e. inefficiency-generating) effects, then reducing their rate will create efficiency gains.
Double dividend: the environment is improved and efficiency gains accrue to the economy as whole.

Question 16

Flow-pollution
Assumption I

Answer 16

Assumption I:
We know the technology, i.e. the production function
Y = F(K)
where output (Y) is usually a concave function of employed capital units (K).

Question 17

Flow-pollution
Assumption II

Answer 17

Assumption II:
Pollution Function
We know the pollution function, e.g.
M = alpha * K
where M = flow pollution, alpha = marginal pollution intensity of capital use.

Benefits Function
Define benefits function = output:
B = Y
and substitute the pollution function
in the production function,
B = F(M/alpha)
Since alpha is given, we can thus define
the benefit function of pollution as
B(M) = F(M/alpha)
where F is increasing and concave in M.

Question 18

Flow-pollution
Assumption III

Answer 18

Assumption III:
We know the parameters of the damage
function,
D = D(M)
where D(M) is usually an increasing and
convex function.
Intuition: damage increases more than
proportionally with pollution levels.

Question 19

Flow-Polllution: Efficency Condition

Answer 19

Maximize Net Benefits:
Find the efficient level of pollution, M*, that maximizes the net benefit:
NB = B(M) - D(M)
The efficiency condition is the standard one in economic problems:
dB(M)/dM = dD(M)/dM
marginal benefits must equal marginal costs.

Question 20

Shadow Price

Answer 20

μ can be interpreted as shadow price of pollution:

• In the absence of a pollution market, this is hypothetical price for pollution externality
• If firms had to pay for polluting, this would be the
  efficient market price

Question 21

Efficient Flow-pollution: Summary
▪ General conclusion
▪ Setting Efficiency Targets requires
and 3 more bullets

Answer 21

▪ General conclusion:
Pollution is associated with some benefits, it is unavoidable for the given technology, and can be tolerated up to a certain amount;

▪ Setting Efficiency Targets requires:
* Knowledge of technology
* Knowledge of pollution intensity
* Knowledge of damage function
▪ Net Benefit Maximization determines efficient levels
▪ Non-convex damages (absolute health criterion)
▪ Uncertainty

Question 22

Suppose that the total damage and the total benefit
functions are given as follows:

D = M^2

        (  96M - 0.2M^2, 0 <= M <= 240
B = {
        ( 1520, M > 240

▪ What is the efficient level of pollution M?
▪ What are the maximized total net benefits NB?
▪ What is the shadow price of pollution?

Answer 22

M* = 40
NB* = B* - D* = 1920
Mu* = 2M* = 80

Question 23

Stock-pollution: Definition

Answer 23

Pollution (P) is a stock that is accumulated
over time according to some dynamic law
dP/dt = M(t) - G(t) - X(t)
where
M(t) is the flow of emissions,
G(t) is the quantity absorbed by the
environment
X(t) is the number of pollution units that
the economy is able to abate at each “t”.

Question 24

Stock-pollution: Implications (5)

Answer 24

▪ What matters for welfare is the level of stock P(t), not just current emissions / economic activity.

▪ Fixing emissions at a given level “M” from “t” onwards does not imply constant pollution from “t” onwards. Inertial dynamics matter.

▪ The absorptive capacity G depends on the stock size. If the pollution stock achieves very high levels, marginal absorption may fall dramatically, implying huge costs of inaction/delayed abatement.

▪ The efficiency of abatement expenditures is a crucial variable.

▪ Uncertainty

Question 25

Efficient Stock-pollution: Assumptions

Answer 25

▪ Assumptions:
Knowledge of the benefit function: B = B(M)
Knowledge of biophysical absorption laws: G = G(P(t))
Knowledge of the damage function: D = D(P(t))
Knowledge of abatement costs: C = C(X(t))
Knowledge of abatement technology efficiency: X(t)

Question 26

Efficient Stock-pollution: Efficiency criterion

Answer 26

Efficiency criterion: present-value maximization

Maximize PV net benefits subject to the dynamic law governing pollution accumulation, the absorption function, and the cost function of abatement.

Question 27

Efficient Stock-pollution: summary

Answer 27

▪ Defining efficiency targets with stock-type pollution imposes more severe informational requirements:
* Knowledge of benefit/damages over time
* Knowledge of biophysical absorption laws

▪ Similarly, harder requirements for instruments:
* Setting the correct combination of emissions/pollution stock levels at each point in time

▪ The link between emissions and pollution stock implies inertial dynamics. Proper knowledge of absorption laws may help in clarifying the costs of
inaction / delayed policies…

Question 28

Suppose that the total damage and the total benefit
functions are given as follows:

D = M^2 and P = 2M in steady state,

        (  96M - 0.2M^2, 0 <= M <= 240
B = {
        ( 1520, M > 240

What are the optimal levels of flow M* and stock P*
pollution?

Answer 28

M* = 48
P* = 96

Question 29

Efficient pollution level

Answer 29

Efficient pollution level is the one that maximizes:

Net Benefits = Benefits - Damage

Question 30

The role of Command-and-Control policy (Pos and Neg)

Answer 30

Negative
If businesses have different abatement costs functions,
command and control regulations result in different marginal costs. This is an inefficient solution (see below)

Positive
Nevertheles, the application of command-and-control
instruments can be advantageous in certain cases:
1. If monitoring costs are high.
2. If the optimal level of emissions is zero or close to zero.
3. In the case of random events and emergencies, which charge the emission-damage ratio.