Lecture #4 - Pollution
1. Precautionary Principle-there is much uncertainty about how much pollution
is needed to damage the environmental resources and to what degree.
- Thus, we do not know what our current choices impact the future - we
should take a stance now to reduce the pollution.
- If we wait and see, then the environmental damage may not be correctable
in the future.
- Global Warming - buildup of greenhouse gases in atmosphere
- Ozone depletion - certain chemicals destroy the ozone layer
- Have a hole in the ozone layer above the South Pole
- Ozone prevents cosmic radiation from entering earth
- Precautionary Principle relates to Safe Minimum Standard
- Safe Minimum Standard - society is unsure of future costs of current
- If natural stocks like fish, mammals, etc dip below a critical
level, then the resource may be irreversibly lost.
- Whales were close to extinction
- Certain fish and animals are becoming extinct
- Problems - both Precautionary Principle and Safe Minimum Standard
- Has no cost-benefit analysis.
- Has three premises.
- Loss of biodiversity may lead to large future losses.
- Future loss is uncertain.
- Intergenerational fairness is a social goal
- How to weigh fairness with future generations?
- How much say does the future get.
2. Cost-Benefit Analysis - Government should use cost-benefit analysis to
evaluate public projects, environmental laws, or resource depletion.
- Marginal benefit (MB) - the additional amount society benefits, if government
supplies one more unit of a resource.
- Public goods - This is the total demand
- Negative slope
- Usually I drop MB and use D for demand for public goods
- Marginal cost (MC) - the increase in cost to society, if government supplies
one more unit of a resource
- Positive slope
- This is the supply for a public good
- Usually government assesses taxes on society to finance projects
- Government maximizes society's return to a public good when MB = MC
- If MB > MC, government should increase one more unit of a public good
- If MB < MC, government should decrease a public good by one unit
- Government builds a new highway
- Businesses and people benefit from the highway if people use it.
- Relieves congestion from surrounding roads and highways
- Creates construction jobs
- Government pays construction companies to build highway
- Government has to assess taxes
- Opportunity costs
- Land could be used for another activity
- Construction companies could build something else
- Government passes a tougher environmental law
- Less pollution
- People and the environment may be healthier from less pollution
- Firms are required to comply with law
- Firms' costs are higher
- Cost-benefit analysis for public projects can be complicated. Easy to
- Government does not have to maximize society's well being.
- Another strategy
is to maximize its finances.
- Maximize tax revenues and minimize government
3. Uncertainty - impossible to describe the current state or predict future
- Uncertainty presents a huge problem for the Precautionary Principle.
- Uncertainty - means is it immeasurable
- Risk is different from uncertainty
- Risk - values can be assigned to risk, usually probabilities
- Example - government requires firms in an industry to invest in a
- Firm has two choices
- Firm complies and invests in equipment
- Marginal cost of compliance
- Firm does not comply
- Firm has a problem of getting caught
- Has probability of getting caught
- Pays penalty
- Has probability of not getting caught, then pays no
- Firm's marginal abatement costs become
- marginal abatement costs = penalty for cheating * probability
caught + MC of compliance
- Government can force compliance by
- Increasing probability of getting caught
- Increasing the penalty if caught
- Uncertainty for environmental problems is highly non-linear
- Damages may be barely noticeable for low levels, but become severe above some uncertain threshold, or tipping point.
- Man should not go beyond the tipping point.
- Our world is too complex, we do not know where the tipping points
4. Irreversibility - a process or choice that is not reversible
- Goes with the Precautionary Principal
- Two types
- Mankind's impact on the environment
- A species goes extinct.
- Pollution kills all living organism in a lake
- Note - some environmental damage is reversible
- A country cuts down its forests
- This country could replant its forests
- Note - Global warming
- Theoretically - it is possible to remove greenhouse gases
out of atmosphere
- Plant more trees, use biofuels, etc.
- Sunk Costs - historical costs that are not recoverable
- Usually firm invests in capital like machines and equipment
- Government forces firms to install equipment to abatement
- Economists - usually do not include sunk costs in cost-benefits
- Choice is already made and not recoverable, so why include
5. Long time horizons
- Economists use the discount rate.
- Incorporate time value of money
- If you receive $1,000,000 in 100 years
- The interest rate is 10%
- Then you place a present value of $45.40 on it today
- You can put $45.40 into bank today and it will grow in $1
million at 10% interest rate
- Use the exponential function for discounting
- where r is discount rate and t is time
- continuous compounding is ert
- Arbitrary to choose discount rate for environmental damage
- Environmental damage can persist for centuries
- Country buries nuclear waste
- Causes $50 million in damage exactly in 200 years
- If a discount rate of 10% is chosen,
- Value of damage today is $0.10
- If a discount rate of 1% is chosen,
- Value of damage today is $6.8 million
- Environmentalists and alarmist choose low discount rates
- Future generations probably would choose a low discount rate
too, but their decisions are not known
- Note - Environmental damage is viewed like a cash flow
- I have environmental damage appearing out of no where and
causing problems in exactly 200 years
Complications of Pollution
1. Pollution sources are defined as two types
- Point source pollution - the pollution has an identifiable source
- Examples - Smoke stacks to factories and electric power plants
- Policies for reducing pollution from Lectures 3 and 4 work well with
- Command and control regulations
- Pigouvian taxes
- Market permits
- Nonpoint source pollution - pollution is emitted from many sources
and it is extremely difficult to identify and monitor.
- Soil erosion - farmers till the soil. The soil is loose,
so rain may erode it.
- Fertilizer and other
chemical runoffs - farmers use fertilizers and chemicals like pesticides
- Rain dissolves the chemicals and they build up in lakes and
- Pollution emissions like CO2 from automobiles
- United States has millions and millions of cars
- Usually large
- Causes asymmetric information
- Polluters have more information than government about their
- Therefore, polluters can take advantage of asymmetry
of knowledge and pollute more.
- Correcting nonpoint source pollution
- Prohibiting the use of certain production methods or require
specific technology standards
- Easier to enforce than direct monitoring of emissions.
2. Pollution is defined as two types
- Flow pollutant - pollutant that the environment can absorb.
- Only the amount that occurs at a specific point in time matters,
like waste flowing into the river.
- The environmental damage may not change over time.
- Stock pollutant - A pollutant that the environment cannot absorb. The
level of the pollutant in the environment grows over time as the pollutant
- Example: CO2 emissions (take 200 years to decay).
- The damage to the environment grows over time.
3. Transboundary externality - pollution emissions in one country or several
countries affect other countries without pollution problems.
- Transboundary pollution
- Acid rain
- Global warming
- Polluted oceans and seas
- Can be point source or nonpoint source
- Acid rain - point source emissions
- Electric power plants burn coal to generate electricity
- Coal contains trace amounts of sulfur
- Burning sulfur creates SOx emissions
- The SOx emissions drift north from the United States to Canada
- Sunlight converts the SOx into sulfuric acid
- Rain pours down taking the acid with it
- The acid dissolves and leeches minerals from the soil, killing
- The Ph decreases in lakes and ponds, killing the fish and other
- Global warming - nonpoint source emissions
- Burning fossil fuels release carbon dioxide into the atmosphere,
allowing the earth to trap more heat.
- It makes no difference where the carbon dioxide was emitted.
- Countries enter into agreements with each other to fix pollution problems
- Montreal Protocol in CFC production
- Kyoto Protocol to fix greenhouse gase emissions at the 1991 level.
- Free rider problem - Game theory is extensively used in
transboundary pollution problems.
- Prisoner’s dilemma
- Two countries: United States and Canada
- Enter agrees to reduce a mutual transboundary pollution
- If both countries choose tough environmental laws, their GDPs grow
- If one country has soft environmental laws and the other has tough,
then industries with the weak laws have a cost advantage.
- They can produce more output, increasing GDP
- They grow at 6%
- If both countries have soft environmental laws, then their GDPs
growth at 5%
- They are producing too much pollution
- United States choice is to choose between tough or soft environmental
- The choices are the green ellipses
- The dominant strategy is to choose the soft environmental laws,
given Canada has a choice.
- The reason is GDP is larger
- Canada’s choice is to choose between tough or soft environmental laws.
- The choices are the red ellipses
- The dominant strategy is to choose the soft environmental laws,
given the United States has a choice.
- The reason is GDP is larger
- We should be at Cell A, but we always end up at Cell D
4. Interjurisdictional competition - local governments compete for
resources, like citizens, companies, jobs, etc.
- United States has three levels of government
- Local governments - county and city government
- If the federal government did not have national standards,
would local government choose lower levels of environmental protection?
- Local governments compete to attract industry
- Local governments offer tax abatements, etc.
- Local government may lower environmental standards if it could
- There is no empirical evidence on whether governments choose less than
optimal levels of protection.
- Firms choose to locate in areas with lower control costs.
- These are likely to be areas with low initial levels of pollution.
- Firms in the United States
- Moved from the North to the South
- From the snow belt to the sun belt
- Then moved to Mexico and then China
- Now, they are moving to Bangladesh
- Industry may ask the federal government to take the lead
- Example - Automobile industry
- U.S. automobile industry opposed federal emission standards for
cars in 1960s
- States started to push for emission standards
- Then car industry pushed for federal standards, because it is easier to have one set of regulations from the federal
government than 50 separate, but different regulations from the 50
- California has passed tougher emission regulations for cars
- California standard and the 49 state standard
- State only has to meet the minimum standard of the federal
- States can choose to set tougher limits
5. The Porter Hypothesis - environmental regulations can increase a firm's
competitiveness through innovation and new technology
- Environmental regulations - causes technological progress that lowers costs and increases quality.
- Benefits of innovation can exceed the cost burden of regulation.
- Robbins Company - EPA was going to shut down this company
because it was discharging contaminated water
- Used water to electroplate jewelry
- Company engineers found a way to recycle the water
- The recycled water was cleaner than buying the water from
the city government
- Company produced higher quality jewelry
- Less jewelry were rejected
- Company's water bill was greatly reduced
- Does not mention how cost increased for purifying the
- Environmental Regulations:
- Provide signals to companies about resource inefficiencies and
areas for potential technological improvements.
- Companies gather information on pollution, increasing
- Reduces uncertainty about investments to reduce pollution
- Gov. is tells them to reduce the pollution
- Imposes costs and burdens on businesses that encourages innovation and progress.
- Levels the playing field
- All companies are subjected to
the same regulations.
- Regulations are costly, because of
- Theoretically, innovation offsets are possible, but there are many counter
- Competitive businesses actively search for profitable innovations and
will not overlook profitable opportunities.
- Have to examine the costs and benefits of environmental
Specific Pollution Types
1. Sulfur Dioxide (SO2)
- Acid rain - caused by sulfur dioxide (SO2) and
nitrogen oxides (NOx).
- Comes from burning of fossil fuels
- Coal contains sulfur
- Car and truck exhaust contains NOx
- Before the 1990, SO2 and NOx were only regulated as
- Electric utility companies would build tall smokestacks that carried
pollution high up into the atmosphere.
- It would not be a local problem
- After 1990 government established a permit market for sulfur dioxide.
- Point Source
- 1,493 electric power plants in the United States
- 1.991 trillion kilowatt-hours per year in 2006
- Reduce SO2 emissions by 10 million tons.
- Requires Continuous Emissions Monitoring Systems (CEMS) - power
plants have to keep track of all their emissions 24 hours a day.
- Current price around $600 per ton
- Program is a success
- In 2007, total SO2 emissions were 8.9 million tons
- Far ahead of the 2020 goal
- Estimated cost savings over command and control regulation: $1
billion per year!
- Flexible standards made using clean coal, rather than a
scrubber, a viable option.
- Deregulation of railroads made
it cheaper to transport low-sulfur coal across United States
- Technological innovation.
2. Ground-Level Ozone (O3)
- When Ozone is near the ground, it is bad.
- When it is high up on
the atmosphere, then it is good.
- Ground-level ozone has significant impact on respiratory
health, crops, vegetation, soil, water, materials, animals,
- Health concerns for people with impaired respiratory systems
- Ozone is highly reactive
- Ozone will oxidize metals, except gold, platinum, and iridium
- Ozone is not formed directly from car and truck exhaust
- Ozone forms as sunlight hits air containing hydrocarbons and nitrogen oxides
- Government policies
- A combination of nonpoint and point source
- Point source - reducing NOx emissions from power plants and
industrial combustion sources
- Introducing low-emission cars and trucks
- Reduce NOx emissions from exhaust
- Use "cleaner" fuels
- Cities with ozone problems have to use reformulated gasoline
- Some components easily evaporate, especially during the summer
- Source of hydrocarbons
- Reformulated gasoline evaporates less easily, but it is more expensive.
- Improving vehicle inspection programs.
- Many states passed vehicle inspection programs for large cities
- Vehicle owners have their car emissions checked each year
- If it passes, then they get an inspection sticker on window
- If cars do not have inspection stickers, then police can pull them over and
- Inspection stickers change color and appearance each year
3. The Montreal Protocol
- Example of a successful international agreement.
- Signed in 1987
- Phase-out the use, production, and exports of chlorofluorocarbons
- Used as a coolant in refrigerators and air conditioners
- CFCs destroy the ozone layer in upper atmosphere
- Contains chlorine that destroys the ozone by turning it back into O2
- Publicity surrounding the ozone hole over Antarctica provided public
- India and China did not sign until1990
- A $260 million fund was established to help finance the
transition to HCFC
- Wanted to reduce leakages - countries that did not sign would start
- Why the Montreal Protocol was successful?
- Most international agreements are not successful
- Only six main companies produce CFCs, so monitoring simple.
- Clean technological substitutes have developed quickly.
- This helped keep the costs of compliance low.
- One substitute, hydrochlorofluorocarbons (HCFC) also depletes
the ozone layer, but at a slower rate.
- It will be phased out by 2030
- Note - both CFCs and HCFCs are greenhouse gases
- The United States passed a tax on CFCs
- Producers paid $1.37 per pound for CFCs in 1990
- The power to tax is the power to destroy
- HCFC became relatively cheaper
- $10 per can
Additional Pollution Economics
1. Civic duty - people and firms may voluntarily reduce their pollution
- Why do firms voluntarily reduce their pollution?
- General Electric's commitment to reduce CO2 emissions
- GE's CEO thinks this will be profitable.
- GE hopes to be a technology leader if regulations are put in place.
- British Petroleum (BP) is investing in green technologies
- Solar panels at gas stations
- United States and Europe have a strong movement for "Being Green"
- Allows firms to differentiate products
- Some consumers are willing to pay a premium for 'green'
- Dolphin-friendly tuna
- Dolphin is smart and cute, and the tuna fish is not
- Organic foods - uses no chemicals like pesticides and
- Preempting tougher regulation
- Industry tries to act first before government passes tougher
- Investor pressure
- "Green" investors may prefer socially responsible firms
- All investors may be concerned about liability from
- Chemical Manufacturers Association started 'Responsible Care
- Started because of the 1984 Union Carbide storage tank leak in Bhopal, India.
- 42 tonnes of toxic methyl isocyanate (MIC) gas were
- Approximately 8,000-10,000 died within 72 hours
- 25,000 have since died from gas-related diseases.
- All chemical companies became part of program
2. Tax codes could perpetuate environmental problems
- Taxes can correct externalities, but can also exacerbate problems.
- United States
- Percent depletion
allowance - Oil and gas producers can deduct a fixed percentage of gross income
- This was established in 1909 to stimulate domestic production.
it still needed?
- Repealing would save $900 million over five years.
- Oil and gas companies can treat exploration and development as an
expense, rather than depreciating over a number of years.
- Repealing would save
$17 billion over five years.
- Encourages greater extraction of virgin
materials, discourages recycling.
- Sport utility vehicle deduction
can deduct $25,000 of purchase of large vehicles (> 6,000 lbs or 2,727 kg) in the first
- No expensing allowed for light vehicles.
- Originally intended for large
equipment (e.g. construction)
- Repealing would save $700 million over five
- The former Soviet Union and Eastern European countries implemented environmental taxes in the late 1970s and early 1980s.
- Create incentives for state owned enterprises to reduce emissions.
- Used complicated engineering formulas, not market based policies
- Could lead to odd results.
- Before 1999, Lithuania charged several million dollars per ton of SO2.
- Not surprisingly, non-payment was an issue.
3. Two Firm Carbon Cap Model
- One firm is an “old plant” with out-dated equipment and technology
- Therefore, firm has high marginal abatement costs.
- Trick - reverse the marginal cost function so it looks like a demand
- Gov. is going to setup a permit system
- This firm will buy permits
- The other firm invests in new technology, and therefore has lower has
lower abatement costs.
- The “new plant’s” low marginal abatement cost curve that
goes left to right with abatement.
- The firm supplies pollution permits
- Firms engage in trade
- The vertical axis become the market price
- The quantity axis becomes the permits
- Firms have an incentive to adopt new technology to reduce their marginal
4. Environmental Damage and Free Trade
- Countries engage in free trade
- Free trade may lead to more environmental damage
- Modify supply and demand for a product that is imported
- No free trade - market price and quantity are PD and QD
- Importing a product
- The world price is PW, QT is total amount consumed, and QD is amount
- Small country case, where country does not influence the world price
- Yellow triangle is the gain from free trade
- Unfortunately the product causes environmental damage.
- If producing the product causes environmental damage
- Marginal Social Cost (MSC)
- Free trade causes less environmental damage to importing country
- Environmental damage is shifted to exporting country
- The green trapezoid is the reduced environmental damage from
- Benefit to importing country
- Unfortunately, consuming the product causes environmental damage within
the importing country
- Country has a true marginal benefits function, D'
- The red trapezoid is the increased environmental damage from
- Cost-Benefit Analysis - Engage in free trade if the marginal benefits of
free trade equal or exceed its marginal costs
- Do not worry about the case for exports
- Do not memorize all the trade agreements!