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Unformatted text preview: Principles of Economics I
Economics 101 Announcements Readings: Chapter 5 this week Discussion Sections this week New assignment available on Ctools this afternoon No quiz Exam 2 March 24th Practice Exam available this afternoon No class that day Exam Location
Section # 401 402 403 404 405 407 409 410 411 Section Time Fr 10:00 AM 11:30 AM Fr 11:30 AM 01:00 PM Fr 01:00 PM 02:30 PM Fr 11:30 AM 01:00 PM Fr 01:00 PM 02:30 PM Th 02:30 PM 04:00 PM Th 11:30 AM 01:00 PM Th 04:00 PM 05:30 PM Fr 02:30 PM 04:00 PM GSI Dimitriy Dimitriy Owen Dan Andrew Annika Annika Dan Andrew Exam Room 1800 CHEM 1800 CHEM 1210 CHEM 1210 CHEM 1800 CHEM 1800 CHEM 1800 CHEM 1210 CHEM 1800 CHEM Office Hours/Review Review Sessions Friday 4pm6pm AH Audidorium D Saturday 4pm6pm AH Auditorium D GSI office hours Usual scheduled office hours Friday 12:001:00 and 3:004:00, MH 3330 My office hours Tues, Thurs 3:00 4:30, Lorch M109 Friday 10:00 12:00, Lorch M109 Monday 2:00 4:00, Lorch M109 Example: Market for electricity from coal generators $/kW/h
MCsoc = MC + MD Supply (MC) MCsoc = MVsoc P* Deadweight Loss Marginal Damage from Pollution (MD) Demand (MV) Qeff Q* Q (kW/h) $/immunization Example: Immunization
Supply (MC) Deadweight Loss MVsoc = MV + MEB Demand (MV) Marginal external benefit (MEB) Q* Qeff Q (people) Pollution Externality: what's the problem? Transactions involve two parties Buyer Seller People other than those two parties are affected by the transaction Interests of those external to the transaction are not represented in the transaction Seller's decisions do not reflect the full social cost of providing the marginal unit Call the pollution cost an external cost or spillover cost How can we solve this problem? Need to make transacting parties consider the external costs/benefits Reflect the external costs in the sellers' costs Reflect the external benefits in the buyers' valuations Call this "internalizing the externality" Private Solutions The Coase Theorem Imposed Solutions Regulation Taxation/Subsidization The Importance of Property Rights Imagine we could Assign the right to use the clean, uncontaminated air Enforce that right Either to breathe, or to pollute These rights could be traded An agent may only pollute air that is hers An agent's right to breathe clean air is only guaranteed if the air is hers Price will reflect the external cost imposed It is the absence of this market that leads to inefficiency Example: Pollution Assign the right to clean air to the general public In order to produce a unit of output, producer must pay for two things: i.e. not the polluters Production costs (reflected in MCprod) The right to pollute the clean air must be purchased from the general public The external cost is "internalized" To buy the pollution right, must pay a price at least as high as the damage imposed by the pollution The producer now faces the full social cost of producing the output Otherwise owners of that right will not sell Production costs + payments that cover the external cost Example: Pollution
$/unit MCprod + P MCprod + MCpollutionpollution right = MCsoc MCproduction MCsoc = MVsoc P* Ppollution right MCpollution MVsoc Q* Qeff Q Example: Pollution Observation: outcome would not have been any different if we had assigned the right to the clean air to the producer Producer still sees two costs Production costs (reflected in MCprod) Opportunity cost of using the pollution right Could have sold it to somebody who valued the clean air Negotiated price will not be above the damage imposed by pollution The external cost is "internalized" The producer now faces the full social cost of producing the output
Production costs plus external costs Private Solutions to Externality Problems Pollution example illustrates that the efficient outcome will obtain in the market if Property rights are defined and enforced over the right to benefit from or impose an externality Agents are free to trade efficiently in these rights The efficiency of the outcome is independent of initial allocation of rights Allocation of rights will affect distribution of wealth though The Coase Theorem The argument that private arrangements will be negotiated to ensure that externalities are internalized is known as the Coase Theorem More generally the Coase Theorem argues that efficient allocations will be secured through private bargaining over the rights to impose externalities E.g. if your production imposes an economic cost on me, we can negotiate to find a mutually beneficial arrangement If there is social surplus available, private parties will find a way to secure it The Coase Theorem Transactions and bargaining costs will often provide a barrier to efficiency improving agreements Example: If a producer pollutes the local water supply, a great many people will suffer damage from the pollution This group is poorly organized, and poorly informed Difficult for this group to bargain successfully with the polluter as a single entity Little incentive for individuals to bargain with the polluter, as any individual receives relatively little of the benefit from pollution abatement Private Solutions to Externality Problems Two questions:
1. Do we ever see private solutions successfully implemented? 1. If these private solutions aren't successful, are there solutions that can be imposed by the state? Are Private Solutions Ever Successful? Markets for Tradable Emissions Permits SO2, CO2 and NOx permits are currently traded Clear Skies Act (2003) authorizes new tradable permit markets (mercury, NOx etc) Referred to as "cap and trade" programs Assigns rights to a limited quantity of the air, and allows trade in those rights Cap the total amount of pollution Allocate permits to pollute amongst polluters Allow them to trade these permits How does "cap and trade" work? Example: coal burning electricity generators produce pollution Permit grants you permission to generate an amount of pollution Using a permit means either SO2, CO2, NOx The cost of polluting now rises Buying it Forgoing the opportunity to sell it Internalizing an externality How does "cap and trade" work? There is a fixed quantity of permits allocated Amount of pollution is predetermined Cannot lower the level of pollution Achieve the target pollution level at the lowest abatement cost Abatement Costs Pollution abatement can be tackled on two margins: Reducing output of the good is costly to society: Reduce output of the good with which the pollution is associated Reduce the amount of pollution produced with each unit of the good Deprive consumers of the good the benefits of consuming it May be less costly to achieve the reduction in pollution by working on the other margin Minimizing abatement costs Using pollution permits, polluters have the incentive to find the cheapest methods of pollution abatement Polluters with high MCabatement buy permits from those with low MCabatement, and need not reduce pollution Polluters with low MCabatement sell their permits and reduce pollution Encourages adoption of newer, cleaner technology only when the costs of that new technology are sufficiently low Encourage reduction in output of the good only when that's the cheapest way to abate pollution Does "cap and trade" yield the efficient amount of pollution? Efficient amount of pollution has marginal damage = marginal abatement cost EPA determines the number of pollution permits available Limits the total pollution Those harmed by pollution could themselves purchase permits and "retire" them Does cap and trade express marginal damage information? If damage from the marginal unit of pollution is greater than the price of the permit Not much activity on this level: benefits of retirement accrue widely, and coordination between those who benefit is costly Alternatives to private solutions: The pollution example Regulation of pollution by command Legislate technology to be used Legislate caps on output of products No way to ensure that the "cheap" method of abatement is used Alternatives to private solutions: The pollution example Taxation of polluting firms We want to "internalize" the external costs of pollution Impose a tax equal to the marginal damage from pollution Parties to the transaction observe both production costs AND taxation costs Equal to the production cost PLUS MARGINAL DAMAGE Pigouvian Tax
$/unit MCsoc MCproduction MCsoc = MVsoc Pc t* P* Pp MVsoc Qeff Q* Q Pigouvian Taxation vs. Coasian Solutions Pigouvian taxation: Coasian Solutions: Need to know information about private costs and benefits If we cannot measure pollution directly, can only manipulate output of the good (not necessarily the low cost approach to abatement No need to know information about private costs and benefits Potentially provides incentives on all relevant margins Requires well defined and enforcable property rights Requires bargaining and transactions costs are low ...
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