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Environmental Regulations
Lecture 16


Point Source Pollution


1. Point source pollution - government can easily identify and monitor the pollution source
  • Examples
    • Emissions from electric power plants
  • Pollution is a negative externality
    • A firm creates pollution that impacts or harms others and the environment
    • Property rights are not well defined
      • The firm treats the environment as common property
      • The firm freely pollutes the environment without paying a price
      • Other parties who want to use the environment are harmed.

2. Government regulations to protect the environment fall into two categories: Command-and-control and market incentives.

  • Command-and-control regulations - government uses laws and regulations that dictate the standards and technology used to reduce pollution.
    • Government tells industry which technology and machines to use
    • Companies are penalized and fined for violating rules.
    • Example
      • Electric power companies have to install "scrubbers" to clean power plant emissions.
    • Advantages and disadvantages
      • Easier to enforce.
      • Freezes technology (limit firm’s flexibility)
      • Firms do not produce at minimum costs; thus, not efficient;
  • Economic incentives - use markets and price mechanism to internalize the externalities
    • Price incentive - pollution taxes, ambient charge, or product charges.
    • Quantity incentive - tradable pollution permits.
    • Voluntary negotiations - Coase Theorem
    • Advantages and disadvantages
      • Gives firms more flexibility.
      • Firms may meet pollution objective with lower costs.

3. Pigouvian tax - a tax placed directly on the pollution.

  • If tax is place on anything else other than pollution, then perverse incentives could exist.
    • Example
      • Electric power plant burns coal to produce electricity
      • If government imposed tax on the amount of coal electric plant burns
        • Firm could lower costs by buying a "dirtier" coal, thus increasing pollution emissions.
      • The tax should be placed on emissions, and not a resource input.
  • Benefit
    • The tax encourages firms to develop new technology for pollution reduction
    • Government collects tax revenue
      • Government could reduce other distortionary taxes
  • Problem
    • Pigouvian taxes require massive amount of information to implement the tax correctly.
  • Refer to market below
  • Market price is P* and market quantity is Q*.
    • Firms freely pollute
  • Government imposes a tax on the pollution
    • Firms reduce their supply
    • Market price increases
    • Market quantity decreases
  • Note - this tax is efficient; unlike the taxes in Lesson 3
    • The tax causes firms to internalize the externality
    • Firms are now paying all costs, including the pollution costs


Market - Pigouvian Tax
A Pigouvian tax

4. Tradable Emission Permits

  • Government sets the maximum limit of pollution or concentration level that any firm is allowed to discharge into the environment. Government gives companies transferable emission permits.
  • Each permit allows a maximum amount of pollution.
    • Can also be quotas, like in fish harvesting
  • Permits are distributed among producers in a region
    • Government could auction permits
      • Auctioning gives government revenue.
    • Government gives permits to the firms (called grandfathering)
      • Grandfathering- firms are less likely to resist the implementation of a permit system, if government disperses permits for free.
  • The permit creates two things.
    • The permit can be sold or bought in a market.
      • Permits have to be:
        • Homogeneous
        • Perfectly divisible
    • The permit creates a market price of pollution.
      • Pollution is a property right
  • Theory
    • Some firms invest in pollution reduction technology
      • These firms can sell some emission permits, because they lowered their pollution emissions
    • Other firms do not invest in technology, and produce same level of pollution
      • These firms can buy permits.
  • Problems
    • Regulators must have sufficient knowledge to design the market.
    • Government has to monitor pollution levels
    • Need legal structure and ensure property rights are well defined..
    • Market may be small, so one or several firms could dominate the market.
  • Examples
    • Sulfur dioxide emissions in United States
    • Quotas on fish harvesting
  • Note, the emissions permit has the same impact as a Pigouvian tax, if government designs market correctly.

5. Coase Theorem

  • Noble laureate Ronald Coase (1960)
  • Disputing parties will work out a private agreement that is efficient,
    • Does not depend which party holds the property right
    • Efficient in this case means parties complete a voluntary exchange and no parties are harmed by the exchange.
  • Could work for small group of people
    • Difficult for large groups of people to agree about something
  • Example
    • A firm dumps pollution into a lake that kills the fish
    • If the right to use the lake is given to the fishermen, then the polluting firm has to negotiate and compensate fisherman in order to pollute the lake
    • If the right is given to the polluting firm, then the fishermen will pay the firm not to pollute the lake.
  • Benefit - private parties solve a pollution problem without government
  • Assumptions
    • Consumers maximize utility and firms maximize profits.
    • Perfect knowledge.
    • Zero transaction costs
    • Costless court system to enforce contracts.
    • No wealth effects


Non-Point and Trans-boundary Pollutions


1. Nonpoint pollution - pollution is emitted from many sources; government cannot identify and monitor the pollution sources.
  • Examples
    • Soil erosion
    • Fertilizer and other chemical runoffs from agricultural fields
    • Pollution emissions from automobiles.
  • Asymmetric information
    • Either the buyer or seller has less information than the other party.
    • Polluting firms can take advantage of asymmetry of knowledge and pollute more.
  • Two forms.
    • Moral hazard - one party misrepresents their actions or behavior
      • Example - a bad driver obtaining car insurance.
    • Adverse selection is where one party does not disclose all information
      • Example - a bad employee portraying himself as a good employee to get hired at a company.

2. Transboundary pollution - pollution emissions in one country affect other countries without pollution problems

  • Examples
    • Acid rain - point pollution
      • U.S. electric power companies emit sulfur oxide
      • Sulfur oxide drifts north to Canada and forms an acid in the clouds
      • Canada suffers from acid rain damage
    • Polluted oceans and seas.
      • Pollution can be non-uniform or uniform in nature.
    • Global warming - non-point pollution
      • Burning fossil fuels release carbon dioxide into the atmosphere
      • More carbon dioxide in atmosphere allows the earth to trap more heat.
      • It makes no difference where the carbon dioxide was emitted.
    • Countries can form an international agency that corrects transboundary pollution.
      • Montreal Protocol in CFC production
        • CFCs are gases used in refrigeration systems
      • Kyoto Protocol to limit a country's CO2 emissions to the 1991 level.
      • Problems
      • Free rider problem
        • Countries that do not join international agency could pollute at higher levels
        • The U.S. did not sign the Kyoto Protocol and is the world's largest polluter.
    • Game theory is extensively used in transboundary pollution problems
    • Could use Prisoner’s dilemma to show two countries that enter a pollution agreement, but the dominant strategy is to violate the agreement.
Blue arrow Countries that pass tough environmental regulations can export pollution to other countries. For example, the United States has been passing tougher environmental laws. Some U.S. firms relocated to Mexico and export their products to the U.S. Mexico tends to be lax on environmental laws and the firms pollute more. Some of the pollution drifts north, affecting the United States.


Waste Disposal and Recycling


Waste disposal and recycling - government usually finances these activities
  • United States landfill capacity is decreasing
    • Solid waste disposal costs are rising
    • Regulatory requirements are increasing.
  • Economics
    • Household size and income increase wastes
    • Fewer pick-ups and fee increases decrease amount of waste produced.
  • Government policies
    • Flat fee pickup - households and businesses pay a fixed charge
      • Provide no incentives to reduce wastes
    • Block pricing - more garbage the government picks up the more households and businesses pay
      • Gives households and businesses an incentive
        • To reduce wastes
        • To increase recycling
        • May increase littering and illegal dumping
    • Example 1 - Portland, Oregon
      • City gov. charges a flat fee for the first garbage can, and additional fees for additional cans.
      • Recycled items are picked up for free.
        • Recycling increases the disposal company’s costs, but increases the life of the landfill.
    • Example 2 - Some states like Michigan
      • Requires all consumers to pay $0.10 per bottle or can
        • Applies to sodas and beer
      • Consumers return bottles and cans to store and receive their refund
        • Cans and bottles are recycled
        • Even if people litter, other people, like kids and homeless people will collect and return the cans for the deposit.

Porter Hypothesis


Porter hypothesis - environmental regulation can spur innovation, increasing a firm's competitiveness
  • Environmental regulation is a cost
  • An innovation results from a regulation lowers costs and increases quality.
    • Benefit of innovation exceeds the cost of regulation.
  • Example
    • Robbins Company - makes jewelry
      • Government was going to shut down company for discharging too much polluted water
      • Company found a way to clean the polluted water
      • Cleaned water was 40 times more pure than purchasing water from city
        • Company produced higher quality and rejected fewer products
        • Company lowered water purchasing costs
          • Company was re-cycling water and did not have to purchase water from the city.
  • Benefits
    1. Regulations inform companies about resource inefficiencies and where to focus potential technological improvements.
    2. Company gathers information about pollution to submit to government
    3. Regulation creates pressure that encourages innovation and progress.
    4. Regulation levels the playing field, because all companies are subjected to the same regulations.
    5. Even if there is no innovation, regulations are necessary to improve the environment.
  • Criticisms (Palmer, Oates, and Portney)
    1. Regulations are costly, because of compliance costs.
    2. Theoretically, innovation offsets are possible, but they are not that common
    3. The private sector systematically searches for profitable innovations and will not overlook profitable opportunities.
    4. Have to examine the costs and benefits of environmental regulations.

Environmental Kuznets Curve


Environmental Kuznet Curve - a hypothesized relationship between environmental degradation and income per capita.

  • The shape of the relationship is an upside down U-shape and shown below.
  • When income per capita is low, a country does not invest in pollution abatement.
    • As income per capita increases, a country invests in more pollution abatement.
  • Common examples.
    • Society goes through transitions
      • Agricultural to heavy industry, which increase pollution.
      • Over time, heavy industry is replaced with services and light industrial, which generates less pollution.
    • Environmental regulations can strengthen over time as country develops.
    • Higher income allows more investment in pollution equipment.
    • Country goes through deforestation and then afforestation
  • Criticism
    • Some pollution levels increase and do not decrease, like carbon dioxide emissions
    • Some countries do not exhibit the Kuznet curve.
      • As developed countries develop pollution abatement technologies, developing countries can implement these technologies at a faster rate, obscuring the Kuznet curve.
      • This is a technological leader-follower model.
Environmental Kuznet Curve
The Kuznet Curve


Besanko, David A. 1987. "Performance versus Design Standards in the Regulation of Pollution." Journal of Public Economics 34(1):19-44.

Coase, Ronald H. 1960. "The Problem of Social Cost." Journal of Law and Economics 3:1-44.

Goodstein, Eban. 2003. “The Death of the Pigovian Tax? Policy Implications from the Double-Dividend Debate.” Land Economics 79(3):402-414.

Palmer, Karen; Oates, Wallace E; Portney, Paul R. 1995. "Tightening Environmental Standards: The Benefit-Cost or the No-Cost Paradigm?" Journal of Economic Perspectives 9(4):119-32.

Porter, Michael E; van der Linde, Claas. 1995. "Toward a New Conception of the Environment-Competitiveness Relationship." Journal of Economic Perspectives 9(4):97-118.

Stern David I. 2004. "The Rise and Fall of the Environmental Kuznets Curve." World Development. 32(8): 1419-1439.


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