Lecture #4 - Pollution


Precautionary Principle


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.
    • Examples
      • 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 environmental degradation.
    • If natural stocks like fish, mammals, etc dip below a critical level, then the resource may be irreversibly lost.
    • Examples
      • 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
  • Examples
  • Government builds a new highway
    • Benefits
      • Businesses and people benefit from the highway if people use it.
      • Relieves congestion from surrounding roads and highways
      • Creates construction jobs
    • Costs
      • 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
    • Benefits
      • Less pollution
      • People and the environment may be healthier from less pollution
    • Cost
      • Firms are required to comply with law
      • Firms' costs are higher
  • Cost-benefit analysis for public projects can be complicated. Easy to manipulate numbers.
  • Government does not have to maximize society's well being.
    • Another strategy is to maximize its finances.
    • Maximize tax revenues and minimize government expenditures.

3. Uncertainty - impossible to describe the current state or predict future outcomes

  • 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 specific technology
      • 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 penalty
    • 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 are.

4. Irreversibility - a process or choice that is not reversible

  • Goes with the Precautionary Principal
  • Two types
    1. 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.
    2. 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 pollution
      • Economists - usually do not include sunk costs in cost-benefits analysis
        • Choice is already made and not recoverable, so why include it.

5. Long time horizons

    • Economists use the discount rate.
      • Incorporate time value of money
    • Example
      • 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
          • e-rt
          • 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
    • Example
      • 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 type
      • Command and control regulations
      • Pigouvian taxes
      • Subsidies
      • Market permits
      • Lawsuits
  • Nonpoint source pollution - pollution is emitted from many sources and it is extremely difficult to identify and monitor.
    • Example
      • 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 rivers
      • 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 pollution
      • 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 is accumulated.
    • 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
    • Examples
      • 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 trees
      • The Ph decreases in lakes and ponds, killing the fish and other life forms.
    • 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.
  • Problems
    • 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 at 1%
    • 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

Prisoner's Dileman where two countries choose the wrong environ. policies

  • United States choice is to choose between tough or soft environmental laws.
    • 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

United States dominant strategy is to choose soft environ. laws

  • 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

Canada's dominant strategy is to choose soft environ. laws

4. Interjurisdictional competition - local governments compete for resources, like citizens, companies, jobs, etc.

  • United States has three levels of government
    • Federal
    • State
    • Local governments - county and city government
      • Each level can pass laws
  • 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 states.
      • 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 government
      • 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.
    • Example
      • 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 water
    • Environmental Regulations:
      1. Provide signals to companies about resource inefficiencies and areas for potential technological improvements.
      2. Companies gather information on pollution, increasing corporate awareness.
      3. Reduces uncertainty about investments to reduce pollution
        • Gov. is tells them to reduce the pollution
      4. Imposes costs and burdens on businesses that encourages innovation and progress.
      5. Levels the playing field
        • All companies are subjected to the same regulations.
    • Criticism
      1. Regulations are costly, because of compliance costs.
      2. Theoretically, innovation offsets are possible, but there are many counter examples.
      3. Competitive businesses actively search for profitable innovations and will not overlook profitable opportunities.
      4. Have to examine the costs and benefits of environmental regulations

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 local pollutants.
    • 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!
    • Why?
      1. Flexible standards made using clean coal, rather than a scrubber, a viable option.
      2. Deregulation of railroads made it cheaper to transport low-sulfur coal across United States
      3. 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, and visibility.
    • 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
      1. Introducing low-emission cars and trucks
        • Reduce NOx emissions from exhaust
      2. 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.
      3. 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 issue citations
          • 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 (CFCs)
      • 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 pressure.
    • 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 producing CFCs
  • Why the Montreal Protocol was successful?
    • Most international agreements are not successful
      • Leakages
      • Cheating
    • 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
      • $5.35 per pound in 1995
    • 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?
  • Examples
    • 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
  • Why?
  • 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' products.
      • Examples:
        • Dolphin-friendly tuna
          • Dolphin is smart and cute, and the tuna fish is not
        • Organic foods - uses no chemicals like pesticides and fertilizers
    • Preempting tougher regulation
      • Industry tries to act first before government passes tougher environmental laws
    • Investor pressure
      • "Green" investors may prefer socially responsible firms
      • All investors may be concerned about liability from environmental pollution
      • Example:
        • Chemical Manufacturers Association started 'Responsible Care Program'
        • Started because of the 1984 Union Carbide storage tank leak in Bhopal, India.
          • 42 tonnes of toxic methyl isocyanate (MIC) gas were released
          • 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 each year.
      • This was established in 1909 to stimulate domestic production.
      • Is 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
      • Businesses can deduct $25,000 of purchase of large vehicles (> 6,000 lbs or 2,727 kg) in the first year
      • No expensing allowed for light vehicles.
      • Originally intended for large equipment (e.g. construction)
      • Repealing would save $700 million over five years.
  • 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 function
  • Gov. is going to setup a permit system
    • This firm will buy permits

Firm needs to 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

Newer firm invests in pollution control technology

  • 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 abatement costs.

One firm buys a pollution permit from another firm

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 produced domestically
    • Small country case, where country does not influence the world price
    • Yellow triangle is the gain from free trade

Free trade - A Small Country Case

  • 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 importing
      • Benefit to importing country

Free Trade - Importing country has less environmental damage

  • Unfortunately, consuming the product causes environmental damage within the importing country
    • Country has a true marginal benefits function, D'
      • Equivalent to the MSC
    • The red trapezoid is the increased environmental damage from importing good
  • Cost-Benefit Analysis - Engage in free trade if the marginal benefits of free trade equal or exceed its marginal costs

Free Trade - Environmental damage to importing country

  • Do not worry about the case for exports
  • Do not memorize all the trade agreements!

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