Environmental Protection

Chapter 13
The Environmental Threat

 Pollution impairs health, reduces life

expectancy, and thus reduces labor-
force activity and output.

 It entails real costs, as measured by

impaired health, reduced life spans,
and other damages.
Air Pollution

 Smog is only one form of air

pollution.
Acid Rain

 Sulfur dioxide (SO2) is an acrid,

corrosive, and poisonous gas created
when high-sulfur fuels are burned.
Smog

 Nitrogen oxides (NOX), another

ingredient in the formation of acid
rain, are also a principal ingredient in
the formation of smog.
The Greenhouse Effect

 Excess buildup of carbon dioxide

(CO2) is creating a gaseous blanket
around the earth.

 The potential effects of this blanket

are intensely debated.
Water Pollution

 Water pollution is another

environmental threat.
Organic Pollution

 The most common form of water

pollution comes from the disposal of
organic wastes from toilets and
garbage disposals.

 Inadequate treatment systems often

result in the closure of waterways and
beaches.
Thermal Pollution

 Thermal pollution is an increase in the

temperature of waterways brought
about by the discharge of steam or
heated water.
Solid-Waste Pollution

 Most solid wastes originate in

agriculture and mining.

 Solid waste originating in residential

and commercial use is considered
dangerous because it accumulates
where people live.
Pollution Damages

 Some monetary measure of

environmental damage is important
to our decision making.

 We won’t get clean air unless we

spend resources to get it.
Assigning Prices

 Economists can estimate the dollar

value of damage by assessing the
economic value of lives, forests,
lakes, and other resources.

 It is difficult to measure the value of

intangibles like lost views of sunsets,
wildlife, and recreation opportunities.
Cleanup Possibilities

 The EPA estimates that 95 percent of

current air and water pollution could
be eliminated by known and available
technology.
Market Incentives

 Market incentives play a major role in

pollution behavior.
The Production Decision

 Business managers seeking to

maximize profit will produce the rate
of output where MR = MC.

 Production decision – The selection of

the short-run rate of output (with
existing plant and equipment).
The Efficiency Decision

 The efficiency decision requires a

producer to choose that production
process that minimizes costs for any
particular rate of output.

 Efficiency decision – The choice of a

production process for any given rate of
output.
Cost of Pollution Abatement

 The efficiency decision does not lead

to a low production of pollution.

 Pollution abatement can be achieved,

but only at significant cost to the
producer.
Cost of Pollution Abatement

 The behavior of profit-maximizers is

guided by comparisons of revenues
and costs, not by philanthropy,
aesthetic concerns, or the welfare of
the environment.
 Profit Maximization in Electric
Power Production
Using cheap but polluting Using more expensive but
process less polluting process
(dollars per kilowatt-hour)

(dollars per kilowatt-hour)

MC1 MC2 MC1
ATC2
ATC1 ATC1
Price or Cost

Price or Cost
Price = MR A P = MR B A

Profit Profit

0 1000 0 1000
Quantity (kilowatt-hours per day) Quantity (kilowatt-hours per day)
Market Failure: External Costs

 People tend to maximize their

personal welfare, balancing private
benefit against private cost.
 They ignore costs that are external to
them.
 External costs are costs of a market
activity borne by a third party.
Externalities in Production

 Whenever external costs exist, a

private firm will not allocate its
resources and operate its plant in
such a way as to maximize social
welfare.

 If pollution costs are external, firms

will produce too much of a polluting
good.
Externalities in Production

 External costs exist when social costs

differ from private costs.

• External costs are equal to the difference

between the social and private costs.
External costs = Social costs – Private costs
Externalities in Production

 Social costs are the full resource

costs of an economic activity,
including externalities.

• Private costs are the costs of an

economic activity directly borne by the
immediate producer or consumer
(excluding externalities).
 Externalities in Production
 The market does not allocate
resources efficiently when external
costs are present.
 This is a case of market failure.
 Market failure – An imperfection in the
market mechanism that prevents optimal
outcomes
Market Failure
Price or Cost (dollars per unit)

Social MC Private MC

A
Price (= MR)
B

External
cost

0 qS qP
Quantity (units per time period)
Externalities in Consumption

 A consumer, like a producer, tends to

maximize personal welfare.

 When people use vacant lots as open

dumps, the polluter benefits by
substituting external costs for private
costs.
Regulatory Options

 There are two general strategies for

environmental protection.
 Alter market incentives in such a way
that they discourage pollution.

 Bypass market incentives with some

form of regulatory intervention.
Market-Based Options

 Market incentives can be used to

reduce or eliminate the divergence
between private and social costs.
Emission Charges
 An emission charge is a fee
imposed on polluters, based on the
quantity of pollution.

 An emission charge increases private

marginal cost and encourages lower
output and cleaner technology.
Emission Charges

 An emission charge might persuade

firms to incur higher fixed costs.

• If emission charges are high enough, firms

will install new technology to avoid the
charges.
Emission Fees

MC + fee
Price or Cost (dollars per unit)

Private MC

Price

Fee = t

0 q1 q0
Quantity (units per time period)
Recycling Materials

 A producer has no incentive to use

recycled materials unless they offer
superior cost efficiency and greater
profits.

 A bonus that emission charges offer is

an increased incentive for the
recycling of materials.
Higher User Fees

 Raising the price consumers pay for

scare resources encourages them to
use less.
“Green” Taxes
 An efficient way to control pollution is
to make those who cause it bear
some of the costs through “green”
taxes.

 “Green” taxes run the gamut from

retail taxes on gasoline to landfill
charges on waste disposal.
Pollution Fines

 Imposing fines or liability for cleanup

costs changes the incentive structure
for firms.
Tradable Pollution Permits

 Tradable pollution permits let firms

purchase the right to continue
polluting.

 The key to the success of polluting

permits is that they are bought and
sold among private firms.
Tradable Pollution Permits

 The system starts with a government-

set standard for pollution reduction.

 Firms that reduce pollution by more

than the standard earn pollution credits
which the may sell to other firms.
Tradable Pollution Permits

 The principal advantage of pollution

permits is their incentive to minimize
the cost of pollution control.

 Entrepreneurs now have an incentive to

discover cheaper methods for pollution
abatement.
Pricing Pollution Permits

Marginal Cost of Pollution Abatement

Reduction in Emissions
Copper Smelter Electric Utility
(in tons)
1 $200 $100
2 250 150
3 300 200
Command-and-Control Options

 With the command-and-control

option, the government commands
firms to reduce pollution and then
controls the process for doing so.

 Excessive process regulation may

raise the costs of environmental
protection and discourage cost-saving
innovation.
Command-and-Control Options
 When process regulation raises the
cost of environmental protection, we
have government failure.

– Government failure – Government

intervention that fails to improve economic
outcomes.
Central Planning

 Some of the worst evidence of

government failure exists in the most
regulated economies.

 Government-directed production isn’t

more environmentally-friendly than
market-directed production.
Balancing Benefits and Costs

 Protecting the environment entails

costs as well as benefits.
Opportunity Costs

 The use of our scarce resources to

clean the environment involves an
opportunity cost.

 Opportunity cost – The most desired

goods or services that are foregone in
order to obtain something else.
 Opportunity Costs

 The environmental expenditures

contemplated by present environmental
policies represent only 1-3 percent of total
output.
The Optimal Rate of Pollution

 Optimal rate of pollution is the rate

of pollution that occurs when the
marginal social benefit of pollution
control equals its marginal social cost.

Optimal Marginal benefit Marginal cost

rate of : of pollution = of pollution
pollution abatement abatement
The Optimal Rate of Pollution

 A totally clean environment is not

economically desirable.

• The costs of environmental protection are

substantial and must be compared to the
benefits.
Cost-Benefit Analysis

 Marginal analysis tells us that a zero-

pollution goal isn’t economically
desirable.
 Some studies suggest the
cost/benefit ratio is extraordinarily
high.
Who Will Pay?

 Whether producers or consumers pay

the cost of reducing pollution depends
on how much competition exists in
the polluting industry and the price
elasticity of demand.
Who Will Pay?

 If producers can pass the cost of

pollution control along to the
consumer, higher prices reduce
pollution in two ways:

– Higher prices help to pay for pollution-control

equipment.
– Higher prices encourage consumers to buy
less polluting goods.
The “Greenhouse” Threat

 Some scientists worry about the

carbon emissions we are now
spreading into the atmosphere.

 They warn that CO2 is warming the

earth’s atmosphere and predict the
polar caps will melt, continents will
flood, and weather patterns will go
haywire.
The Green House Effect

 Scientists fear there is a build-up of

carbon dioxide might trap heat in the
earth’s atmosphere, warming the
planet.
The Skeptics

 Other scientists are skeptical about

both the temperature change and its
cause.
Global Externalities

 One thing is certain, CO2 emissions

are a global externality.

 Without some form of government

intervention, there is little likelihood
that market participants will
voluntarily reduce them.
Kyoto Treaty

 In December of 1997, most of the

world’s industrialized nations pledged
to reduce CO2 emissions.

 The Kyoto Treaty encourages nations

to develop a global system of
tradable pollution permits to
encourage cost efficiency.