Chapter Five

Economics
of
Pollution Control
and
Environmental Policy
 5.1. Pollutant taxonomy
*The amount of waste products emitted determines
the load upon the environment.
*The damage done by this load depends on the
capacity of the environment to assimilate the waste
products.
*We call this ability of the environment to absorb
pollutants its absorptive capacity.
*If the emissions load exceeds the absorptive capacity,
then the pollutant accumulates in the environment.
*Pollutants for which the environment has little or no
absorptive capacity are called stock pollutants.
* Stock pollutants accumulate over time as emissions enter the
environment.
* Examples of stock pollutants include non biodegradable
bottles tossed by the roadside; heavy metals, such as lead, that
accumulate in the soils near the emissions source; and
persistent synthetic chemicals.
* Pollutantsfor which the environment has some absorptive
capacity are called fund pollutants.
* Forthese pollutants, as long as the emissions rate does not
exceed the absorptive capacity of the environment, the
pollutants do not accumulate. For example
A. Many organic pollutants injected into an oxygen-rich
stream will be transformed by the resident bacteria into less
harmful inorganic matter.
B. Carbon dioxide is absorbed by plant life and the oceans.
* The point is not that the mass is destroyed; the law of conservation of mass
suggests this cannot be the case.
* Rather, when fund pollutants are injected into the air or water, they may be
transformed into substances that are not considered harmful to people or to
the ecological system, or they may be so diluted or dispersed that the
resulting concentrations are not harmful.
* Pollutants can also be classified by their zone of influence, defined both
horizontally and vertically.
* The horizontal dimension deals with the spatial domain over which damage
from an emitted pollutant is experienced.
* The damage caused by local pollutants is experienced near the source of
emission, while the damage from regional pollutants is experienced at
greater distances from the source of emission.
* The limiting case is a global pollutant, where the damage affects the entire
planet.
* The categories are not mutually exclusive; it is possible for a pollutant to be
in more than one category. Sulfur oxides and nitrogen oxides, for example,
are both local and regional pollutants.
* The vertical zone of influence describes whether the damage
is caused mainly by ground-level concentrations of an air
pollutant or by concentrations in the upper atmosphere.
* For some pollutants, such as lead or particulates, the damage
caused by a pollutant is determined mainly by concentrations
of the pollutant near the earth’s surface.
* For others, such as ozone-depleting substances or greenhouse
gases the damage is related more to their concentrations in the
upper atmosphere.
 5.2. Efficient allocation of pollution
* Pollutants are the residuals of production and consumption.
* These residuals must eventually be recycled or returned to
the environment in one form or another.
* Since their presence in the environment may depreciate the
service flows received, an efficient allocation of resources
must take this cost into account.
What is meant by the efficient allocation of pollution depends
on the nature of the pollutant.
5.2.1. Stock pollutant
The efficient allocation of a stock pollutant must take into
account the fact that the pollutant accumulates in the
environment over time and that the damage caused by its
presence increases and persists as the pollutant accumulates.
* By their very nature, stock pollutants create an
interdependency between the present and the future, since
the damage imposed in the future depends on current
actions.
* The damage caused by pollution can take many forms. At
high enough exposures to certain pollutants, human health
can be adversely impacted, possibly even leading to death.
* Other living organisms, such as trees or fish, can be harmed
as well. Damage can even occur to inanimate objects, as
when acid rain causes sculptures to deteriorate or when
particulates cause structures to discolor.
* Suppose, for example, that we consider the allocation of a
commodity that we refer to as X. Suppose further that the
production of X involves the generation of a proportional amount
of a stock pollutant.
* The amount of this pollution can be reduced, but that takes
resources away from the production of X.
* The damage caused by the presence of this pollutant in the
environment is further assumed to be proportional to the size of
the accumulated stock. As long as the stock of pollutants
remains in the environment, the damage persists.
* Thedynamic efficient allocation, by definition, is the one that
maximizes the present value of the net benefit.
* In this case the net benefit at any point in time, t, is equal to the
benefit received from the consumption of X minus the cost of the
damage caused by the presence of the stock pollutant in the
environment.
* This damage is a cost that society must bear, and in terms of
its effect on the efficient allocation, this cost is not unlike
that associated with extracting minerals or fuels.
* While for minerals the extraction cost rises with the
cumulative amount of the depletable resource extracted, the
damage cost associated with a stock pollutant rises with the
cumulative amount deposited in the environment.
* the major difference between extraction cost and damage
cost is that the extraction cost is borne only at the time of
extraction, while damage persists as long as the stock
pollutant remains in the environment.
* The efficient quantity of X (and therefore, the addition to the
accumulation of this pollutant in the environment) would
decline over time as the marginal cost of the damage rises.
* The price of X would rise over time, reflecting the rising
social cost of production. To cope with the increasing
marginal damage, the amount of resources committed to
controlling the pollutant would increase over time.
* Ultimately,a steady state would be reached where
additions to the amount of the pollutant in the
environment would cease and the size of the pollutant
stock would stabilize.
* At this point, all further emission of the pollutant created
by the production of X would be controlled (perhaps
through recycling). The price of X and the quantity
consumed would remain constant. The damage caused
by the stock pollutant would persist.
5.2.2. Fund pollutant
* To the extent that the emission of fund pollutants exceeds the
assimilative capacity of the environment, they accumulate and
share some of the characteristics of stock pollutants.
* And when the emission level is below the assimilative capacity
of the environment, current emissions cause current damage
and future emissions cause future damage, and the level of
future damage will be independent of current emissions.
* Our ultimate objective behind the determination of the efficient
point would to maximize the net benefit from waste flows.
* But rather than the benefit, we would be focusing on the two
costs associated with pollution, damage costs and control or
avoidance cost.
 Damage cost
* The marginal damage caused by a unit of pollution increases
with the amount emitted.
* When small amounts of the pollutant are emitted, the
incremental damage is quite small. However, when large
amounts are emitted, the marginal unit can cause
significantly more damage.
* And that is because small amounts of pollution are easily
diluted in the environment, and the body can tolerate small
quantities of substances. However, as the amount in the
atmosphere increases, dilution is less effective and the body
is less tolerant.
* Graphically it would be represented by upward sloping
curve with marginal damage curve on the vertical axis and
quantity of pollution on the horizontal axis.
 Control cost
* Marginal control costs commonly increase with the amount
controlled.
* When producers emit more pollutant to the environment that
indicates they are spending relatively less on control
expenses. And if producers are emitting less that means they
are spending more on control .
* Graphically it would be represented by downward sloping
curve with marginal control cost on the vertical axis and
quantity of pollution on the horizontal axis.
* The efficient allocation of the fund pollutants would be
determined where the downward sloping marginal control
cost and upward sloping marginal damage cost cross each
other.
MDC, MCC

Quantity of pollution
Total damage cost Total control cost
* Greater degrees of control (points to the left of Q*) are
inefficient because the further increase in avoidance costs
would exceed the reduction in damages.
* Similarly, levels of control lower than Q* would result in a
lower cost of control but the increase in damage costs
would be even larger.
* Increasing or decreasing the amount controlled causes an
increase in total costs. Hence, Q* must be efficient.
* Notice that the efficient size of pollution is not zero we do
not reduce that damage to zero because the cost of doing so
would be too high.
Classification of pollution control instruments
1. Institutional approaches to facilitate internalization of externalities
A. Facilitation of bargaining
B. Specification of liability
C. Development of social responsibility
2. Command and control instruments
A. Emissions licenses (non transfereable, or non tradable permits)
B. Output controls: Output quotas or prohibitions
C. Input controls over quantity or mix of inputs
D. Technology controls
3. Economic incentive (market-based or quasi market) instruments
A. Emissions charges/taxes
B. User charges/fees/natural resource taxes
C. Product charges/taxes
D.Emissions abatement and resource management subsidies
E. Marketable emission permits
F. Deposit-refund systems
G. Non-compliance fees etc
 1. Institutional approaches to facilitate internalization of
externalities
* Each approach presented here shares the characteristic of
potentially preventing the emergence of externalities, or
internalizing externalities which have arisen.
* Indoing so, it is possible that decentralized behavior by
consumers and producers may generate efficient outcomes
and so obviate the need for the regulatory intervention, at
least if targets are set on efficiency grounds.
1.1. Facilitation of bargaining
* Generating efficient result through bargaining might be
challenging. The case is even more true for the case of
environmental goods. How?
* First, the likelihood of bargaining taking place is low unless
enforceable property rights exist.
* For many environmental resources, well-defined and
enforceable property rights do not exist.
* Second, bargaining is facilitated with the existence of a
relatively small number of affected parties, and by all such
parties being easily identifiable. Again, many environmental
problems fail to satisfy either of those properties.
* The transactions costs associated with undertaking a
bargaining exercise can be enormous.
* Hence where the number of affected individuals is large, the
scope for efficient bargaining behavior is very restricted.
1.2. Liability
* The liability principle is related to property rights. Where
pollution is a private good, the liability is equivalent to a
statement of enforceable property rights vested in the
victims, and enforcement would be done through civil law.
* But where pollutant is a public good a public good, this
way of making the polluter pay is not usually feasible.
* In that case, the EPA acts as an agent of the public interest,
enforcing the liability principle on behalf of affected
parties.
* One difficulty arises where damage only becomes apparent
a long time after the relevant pollutants were discharged.
Tracking down those who are liable may be a substantial
undertaking, and those responsible – individuals or firms –
may no longer exist.
 3. Development of social responsibility
* Pollution problems happen, in the final analysis, because of
self-interested but uncoordinated, or sometimes
thoughtless, behavior. Encouraging people to behave as
responsible citizens can help to attain environmental goals.
1. Command and control (emission standard)
* The dominant method of reducing pollution in most
countries has been the use of direct controls over polluters.
This set of controls is commonly known as command and
control instruments.
* Emissions are by-products in the production of intended
final output. The amount (and type) of emissions will
depend on which goods are being produced, and in what
quantities.
* It will also depend on the production techniques being
employed, and on the amount (and mix) of inputs being
used.
* For uniformly mixing pollutants (UMPs), pollution levels
will depend only on total emissions levels.
* Inthe case of non-uniformly-mixing pollutants the spatial
distribution of ambient pollution levels will also depend on
the location of emission sources.
* Command and control instruments can be designed to
intervene at any of these stages.
* Such regulations may be applied to outputs of emissions
themselves, to the quantity of final production, to
production techniques used, or to the level and/or mix of
productive inputs. For non-UMPs, controls may also apply
to location of emission sources.
* In general, there should be advantages in directing the
controls at points closest to what is ultimately being
targeted: that is, ambient pollution levels.
* This allows polluters the most flexibility in how a
pollution reduction is to be achieved.
2. Non-transferable emissions licenses
Suppose that the EPA is committed to attaining some overall
emissions target for a particular kind of pollutant. It then
creates licenses (also called permits or quotas) for that total
allowable quantity.
* We use the term non-transferable licenses to refer to a
system where the licenses cannot be transferred
(exchanged) between firms: each firm’s initial allocation
of pollution licenses sets the maximum amount of
emissions that it is allowed.
* Successful operation of license schemes is unlikely if
polluters believe their actions are not observed, or if the
penalties on polluters not meeting license restrictions are
low relative to the cost of abatement.
* License schemes will have to be supported, therefore, by
pollution monitoring systems and by sufficiently harsh
penalties for non-compliance.
 3. Economic incentive or quasi market instruments
* Incentive-based instruments work by creating incentives for
individuals or firms to voluntarily change their behavior.
* Taxes, subsidies and transferable permits create markets (or
quasi-markets, something equivalent to markets) for the
pollution externality.
* Inthese markets, prices exist which generate opportunity
costs that profit maximizing firms will take account of in
their behavior.
3.1. Emissions taxes and pollution abatement subsidies
A tax on pollutant emissions has for long been the instrument
advocated by economists to achieve a pollution target.
* Graphically, we can represent it as
Marginal benefit
MBAT MBBT Marginal damage

Q1 Q2 Pollutions size
MBAT represent marginal benefit after tax and MBBT represents marginal
benefit before tax.
2. Marketable emission permits
* As with command and control and tax/subsidy instruments,
marketable permits (also known as tradable or transferable
permits) can be applied at many points in the production-to-
pollution process.
* Marketable permit systems are based on the principle that
any increase in emissions must be offset by an equivalent
decrease elsewhere.
* There is a limit set on the total quantity of emissions
allowed, but the regulator does not attempt to determine
how that total allowed quantity is allocated among
individual sources.
* There are two broad types of marketable emission permit
systems – the ‘cap-and-trade’ system and the emission
reduction credit (ERC) system.