436 Lecture Note 4 SP16 - 4.1 ECON 436 SP16 Lecture 4...

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4.1 ECON 436 SP16 Lecture 4 Outline Policy design when MB and MD curves are known, continued Monitoring and enforcement Monopolistic polluter Non-monotonic marginal damages Non-convexity of total net benefits Monitoring and enforcement Even when the MB and MD curves are known, as assumed here, a polluter’s actual level of pollution at any given time will not be known unless resources are devoted to monitoring it. If a regulation is used, monitoring is necessary to ensure that the regulation is being obeyed, and if a Pigouvian tax is used, monitoring is necessary to determine the correct amount of tax is being paid. In either case, polluters will have an incentive to pollute more than the efficient level and falsely report their actual level. Therefore in addition to monitoring, enforcement is required to prevent this type of cheating. If a polluter reports that its level of pollution is Q*, when the actual quantity of pollution, Q A , is greater than Q*, its benefit from cheating, B, will be equal to the abatement costs it saves from doing so. The probability of being caught, π , will be a function of the amount the government spends on monitoring and enforcement, M, and the expected punishment if caught cheating will be equal to π times the dollar value of the penalty, C. The economics of crime predicts that a polluter will cheat if, and only if, the expected net benefit is positive, B – π (M)C > 0. Because the expected punishment is equal to the product of π and C, the same level of deterrence can be obtained by either (i) a low value of π and a high value of C or (ii) a high value of π and a low value of C. Because increasing π requires spending more money on monitoring, alternative (ii) will cost the government more than alternative (i). Therefore for a given level of deterrence the higher the penalty the lower the cost of monitoring and enforcement. If a Pigouvian tax is used and the polluter is caught, they would have to pay additional tax equal to tQ A , which would usually not be much larger than B. Therefore, if
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4.2 ECON 436 SP16 this was the only penalty, expenditure on monitoring and enforcement would have to be substantial, whereas if a regulation is used the penalty could be much larger and monitoring and enforcement costs less. Therefore it appears that consideration of monitoring and enforcement costs demonstrates an advantage to using a regulation rather than a Pigouvian tax. However, the Pigouvian tax could be supplemented with a penalty for false reporting that made the total penalty similar to the penalty under a regulation. It should be noted that in some cases it is very difficult or impossible to monitor the actual quantity of emissions. For example, for some types of pollution Q* may be less than the monitoring instruments are able to measure. In these cases regulating the specific types of pollution control equipment that have to be installed may be the only practical way to attain an enforceable decrease in emissions.
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