Unformatted text preview: EEP 101/ECON 125
David Zilberman Outline
Outline Property rights and the Coase Theorem
The economics of clean up and restoration
Political economy models Capture
Rent seeking Property Rights and the
Environment Property rights define entitlement that cannot
be taken away
Polluters may have rights to pollute Precedent establishes rights in many cases
A chemical plant gets the right to pollute when a
plant is established
plant Victims (pollutees) may have protection rights
from pollutions Downstream users have rights to clean water The Coase Theorem
The Assumptions Property rights are clear and enforceable
Zero transaction costs Then No need for intervention in cases of externalities
Regardless of initial distribution of rights Negotiations and the Coase
Outcomes Clear property rights lead to Pareto-efficient
The exact distribution of surplus gain depends
We assumed the parties are splitting the
In case of polluter rights, the pollutees pay the
polluters not to pollute
In case of pollutee rights, the polluter pays the
pollutee to pollute Initial outcome B: Pollutee pays CEBD, gains CEF
Final outcome C: Polluter gains BCE, the social gain is
FCB Gain to polluters
benefits C D
CASE OF POLLUTER RIGHTS E B Initial outcome A: Polluter pays GCDA, gains DCG
GCDA gains DCG
Final outcome C: Polluter gains GCA, the social gain is
DCA Gain to polluters
benefits C Marginal
benefits G A
CASE OF POLLUTEE RIGHTS E B Implications and Limitations of
Coase A functioning legal system is key for
Externalities are caused by
Externalities The Coase Theorem works when Missing markets
Undefined property rights
Small number of actors and low transaction costs It does not work when there are many parties
and negotiation and collaboration are costly Liability Rules
Liability Allow violation of property rights but impose penalties Polluters have to pay damages for accidental water
contamination and pay a penalty for intentional actions
Pollution tax is a liability payment Negligence Rules: Penalize individuals for not exercising sufficient care in
action. Due care standards set basis for liability
A farmer may not be liable for run-off damages if she
performed due care. Part of policy is establishing these
standards Inalienability: Inalienable rights are rights
which cannot b e sold or transferred, for
example, rights to freedom and to life itself.
Reasons for inalienable rights:
Cognitive Disson ance: People tend to think nothing bad
will happen to them. May cause people to work against
their sel f-interest; for example:
1) Refusal to w ear s eatbelts or h el m ets 2) Farm w orkers m a y not w ea r safet y ge ar 3) Alcoholics and d rug addicts m a y refu s e to accept trea tm ent Examples: Suic ide & selli n g y o urself for slavery are
illegal Full Restoration May Be
e MC of Restoration
MB of Restoration Q*
Q* = Full Restoration Q = Optimal Restoration Q Quantity Waste Management
Waste Liability may be retroactive; new owners are
liable for pollution of old ones.
It leads to care in purchases of new properties
and prevents people from polluting and selling.
In cases of ex-Soviet Union may prevent
development. To buyers many sites are worth
less than the clean-up cost.
Governments may pay if the public gains from
clean up and development is greater than the
private Point vs. Nonpoint Source
Pollution When pollution can be assigned to polluters,
we we have source point
source For example, when each smokestack is monitored When individual pollution cannot be assigned,
we have nonpoint source
Pollution at point source can be taxed
In case of nonpoint pollution of individuals who
cannot be observed, other actions related to
pollution can be regulated or taxed
pollution Contamination by Firms:
Point vs. Nonpoint
Point Suppose that there are N firms, each firm is
indexed by n who assume values from 1 to N
Pollution of the nth farmer is Zn. It is produced
by the input of this farmer Xn.This input is
generating output Yn.
The production function of the nth producer is
Yn = Fn(Xn). The pollution function of the nth
producer is Zn = Gn(Xn)
Suppose output price is P, iinput price is W, and
pollution damage per unit is V. Case of Point Source
Case If the policymaker can observe Zn, he will charge the
nth firm VZ. It will lead to optimal outcome.
The optimal choice of the firm will be
PFn ( X n ) − Ω Ξν − ς Γ ν ( Ξν )
Xn The optimality is At optimal outcome
At ∂Φ ( Ξν )
∂Γ ν ( Ξν )
− Ων − ς
∂Ξ Value of marginal benefit of production is equal to - input price plus
- marginal pollution damage cost Example
Example Fn ( X n ) = αν Ξν − βν Ξν 2 ⊇ ν ( Ξ ν ν ) = χν Ξν 2
If Optimality condition
Implying Pan − 2 Πβν Ξν − Ω − 2χνς Ξν = 0 Xn = .5(Παν − Ω ) / (Πβν + ς χν ) If an = 2 ⊇βν = .1⊇ν = 1,⊇Π = 10 ⊇ = 2,⊇ = 2
ς τηεν⊇⊇⊇⊇ ν = .5(20 − 2) / (1 + 2) = 3
⊇⊇⊇Ξ A tax of $2 will lead to optimality if Zn is observable.
tax If Zn is not observable but Xn is a tax on input 2VcnXn,
it will also be optimal. In our case the input tax is $12. Heterogeneity
Heterogeneity Suppose all firms have the same production
function, but vary in pollution function.
50% have cn = 1, and the other 50% have cn = 0.
If the policymaker observes Zn,
-Firms with cn = 1 pay a tax of $2 per unit of pollution and
produce 3 units making
produce 10(2 * 3 − .1 ∗ 32 ) − 2 ∗ 3 − 9 ∗ 2 = ∃27 -The clean firms have Xn = .5(20 - 2) = 9 and make
10(2 * 9 − .1 ∗ 9 2 ) − 2 ∗ 9 = ∃81
-Average income is $54 per firm Nonpoint Source
Nonpoint If only Xn is not observable, the policymaker will
optimize average behavior.
Thus, the tax will be based on $2 per unit of output
resulting in output of Xn = .5(20 - 2)/(1 + 1) = 6.
The profit per firm will be 10(2 * 6 − .1 ∗ 6 2 ) − 2 ∗ 6 = ∃72.
The social welfare will be $72 for clean firms and 0 for
dirty ones since the cost of their pollution is 2 * 36.
Average welfare is $36 per firm.
Information will generate welfare gain of $9 per firm. The Gain from Information
MECH Avg. MEC MB
High Tax A
C Avg. Tax MECL
E Low Tax B D The area ABC is loss of pollution generated by dirty firms.
The area CDE is loss of insufficient pollution by cleaner firms. Investment in Monitoring
Investment Monitoring of pollution allows discrimination
among polluters and non-polluters and
If monitoring cost is greater than the gain from
information, do not invest.
Governments can induce monitoring by
assuming that everyone is a heavy polluter and
is being taxed accordingly. Refunds will be
issued to firms that prove to be clean.
This leads to an industry of monitoring and
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