Regulatory Options

1
Regulatory Options Efficiency

• What guidance can economics provide about how to
  regulate polluting industries or firms?

2
Why regulate?

• Does free market efficiently provide goods and
  services?
• Market failure (externalities, public goods,
  etc.)
• Market power (monopolies inefficiently restrict
  production to raise prices)
• Information problems (damages uncertain, food
  safety, env quality)

3
Types of questions in regulation

1. What is the optimal amount of pollution?
2. To reduce by X, who should reduce and by how
   much?
3. What regulatory instrument(s) should be used to
   achieve that level?

4
The efficient amount of pollution
Marginal Control Cost
/unit
Marginal Damage Cost
Total Damage Cost
Total Control Cost
Q
Units of pollution
5
Recall example from 1st day

• 60 firms, each pollute 100 tons
• 30 low abatement cost (100/ton)
• 30 high abatement (1000/ton)
• Everyone reduces 1 ton Cost33,000
• Total reduction 60 tons.
• For same cost could have reduced 330 tons.

6
If low cost firms abate

• Either
• Reduce more pollution for the same amount of
  moneyor
• Reduce the same amount of pollution for less
  money.
• So we always want low-cost firm to abate.

7
If costs arent constant greenhouse emissions of
Nitrogen
Cost ()
Who should abate the 1st unit of N?
MCA
MCB
? N
8
How much abatement from each?
(A)
MCA
Loss from equal reduction
(B)
MCB
0
A
40
80
25
80
0
40
55
B
9
How did he do that?

1. Determine how much total abatement you want (e.g.
   80)
2. Draw axis from 0 to 80 (A), 80 to 0 (B)
3. Sum of abatements always equals 80.
4. Draw MCA as usual, flip MCB
5. Lines cross at equilibrium
6. Price is MC for A and for B.

10
The equimarginal principle

• Not an accident that the marginal abatement costs
  are equal at the most efficient point.
• Equimarginal Principle Efficiency for a
  homogeneous pollutant requires equating the
  marginal costs of control across all sources.

11
Control costs

• Should include all other costs of control
• monitoring enforcement
• administrative
• Equipment
• High cost firms have incentive to innovate and
  change production technology
• Regulatory uncertainty increases costs.

12
Instruments for regulation

• Taxes charge X per unit emitted. This
  increases the cost of production. Forces firms
  to internalize externality.
• Quotas/standards uniform standard (all firms can
  emit Y) or non-uniform.
• Tradable permits All firms get Y permits to
  pollute, can buy sell on market. Other initial
  distn mechanisms.

13
Example 1 Taxes in China

• China extremely high air pollution causes
  significant health damage.
• Instituted wide-ranging system of environmental
  taxation
• 2 tiers
• World Bank report estimates that MC of abatement
  ltlt MB of abatement.

14
A creative quota bubble policy

• Multiple emissions sources in different
  locations.
• Contained in an imaginary bubble.
• Regulation only governs amount that leaves the
  bubble.
• May apply to emissions points within same plant
  or emissions points in plants owned by other
  firms.

15
Example 2 Bubble policy in RI

• Narraganset Electric Company
• 2 generation facilities in Providence, RI.
• Required to use lt 2.2 sulfur in oil.
• Under bubble policy
• Used 2.2 in one plant, burned natural gas at
  other plant
• Savings
• 3 million/year

16
/unit
MSC
MPC
P
MEC
Pp
D
Dirty Good
Qc
Q
17
What tax or quota is required?

• We know
• Optimal level of pollution is Q
• Marginal Social Cost at the optimum is P
• Marginal Private Cost at optimum is Pp.
• Optimal tax exactly internalizes externality
• t P - Pp
• Effectively raises MC of production

18
MPC (with tax)
/unit
MSC
t
MPC (no tax)
P
Pp
D
Q (pollution)
Qc
Q
19
Taxing consumption instead

• Taxing consumption
• Taxing consumers for every unit of a polluting
  good that is purchased.
• E.g. Automobile gasoline
• Can equivalently be used
• Instead of raising production costs, a
  consumption tax lowers demand.

20
/unit
MSC
MPC (no tax)
P
Pp
t
D (no tax)
D (with tax)
Q (pollution)
Qc
Q