Command and Control

Government establishes the efficient level of pollution (level at which MB of abatement = MC of abatement) Government establishes a standard-- a maximum level of pollution-- that all firms must meet. For example, a firm's emissions must contain no more than 3 parts per million of some chemical. The government orders firms to install particular anti-pollution/abatement devices to meet the target. All firms must reduce pollution to the same level and use the same technology. firms that do not meet the standard or install the anti-pollution devices must pay a penalty.

Regulation is inefficient

All firms must adopt the same technology, whether or not it is the cheapest way for the individual firm to reduce pollution or not. All firms must reduce pollution to the same extent, regardless of the cost of abatement. There is no incentive for firms that can clean up cheaply to do more. Once firms have installed the required devices, there is no incentive to find and install cheaper ways of reducing pollution.

Pollution taxes

The government taxes firms based on the quantity of pollutants they emit into the air or water. The tax rate should equal the marginal external cost of pollution (the extra harm done by an additional bit of pollution. Firms will voluntarily reduce the level of pollutants. If the cost of installing anti-pollution devices is less than tax would be, the firm's profits will improve if it reduces its pollution. Firms will pay the tax for emissions that cost more than the tax to eliminated. The tax adds to firms' costs. The market supply shifts to the left, raising prices and reducing output. Less production means less pollution.

Taxes are more efficient than controls

Pollution taxes do not require the use of a particular technology. Firms are free to adopt a different technology that can reduce the pollution at lower cost for their particular production process. Firms that can reduce pollution cheaply have an incentive (the tax saving) to do more than the miminum abatement. Firms have an incentive (tax savings) to find and adopt new, lower cost technologies for reducing pollution. Tax rates can be adjusted more easily than regulations over time to cope with economic growth and changing conditions. In addition, the government gets tax revenues to help offset the cost of running the program.

Pollution Permits (allowances)

The government decides the efficient level of pollution and issues permit for the emission of some quantity of a pollutant into the air or water. For example, the EPA has set the level of allowable sulphur dioxide at 8.95 million tons annually. It then issues allowances which authorize a firm to emit one ton of SO2 during the year. The government distributes some permits among existing firms and sells the others at auction. Firms which hold allowances may resell them. Firms are required to monitor their emmissions and to send the information to the EPA, which periodically checks the monitoring equipment At the end of the year, the firm must have allowances equal to its annual emissions. Those that do not have their difference deducted from their next year's allocation and are penalized.

The Market for Permits

Permits may be bought or sold. A firm compares the market price for a permit with its cost of reducing pollution by an equivalent amount and chooses the cheaper option. If abatement is costly, the firm will be trying to purchase allowances. If the firm can reduce pollution cheaply, it can increases its profits by eliminating the pollution and selling its permits. Individuals or groups who think the optimal level of pollution is lower than that allowed by the government can also purchase allowances, taking them off the market, and forcing additional reductions in pollution.

Information on the price of SO2 permits and recent auction results. Check the links for this information from the EPA.

Conditions for Using Permits
there are a significant number of sources over a wide area responsible for the pollution. the cost of controls varies from source to source emission can be consistently and accurately measured.

Advantages of Permits

Effciency: firms choose the cheapest method of reducing pollution in their production process. Firms have an incentive to reduce pollution more so they can sell permits they hold for extra revenue. They also have an incentive to find and adopt new technologies for abatement. The fixed number of allowances sets a maximum level of pollution regardless of the level of output. The market establishes the price so the government doesn't have to guess at an appropriate tax rate to achieve the desired result. The number of allowances issue can be reduced over time to further improve environmental quality. The government's administrative costs are low and revenue is received from the auction of permits to help offset these costs.

External Costs of Consumption

Costs may be imposed on thrid parties as a result of consumption of a good. Examples include health effects of second-hand smoke, pollution caused by driving cars, and injuries caused by alcohol-related accidents. Because not all the costs are reflected in the price buyers pay, society will not produce at the efficient level but will produce too many of these goods. Government usually seeks to correct this inefficiency by prohibiting the sale of the good, requiring anti-pollution devices as standard equipment (anti-pollution devices on cars) or to taxing the good (cigarettes). Sales taxes on specific goods (excise taxes) such as cigarettes or gasoline raise the seller's cost, reducing supply. The price to consumers increases, inducing them the cut back their consumption of the good and hence the pollution generated. The government can use the tax revenues to encourage a change in consumer taste away from the good or to clean up the pollution.

Effects of Government Policies
The US uses a combination of these methods, not just command and control. Even where such regulations are still used, the government applies them to the plant site as a whole, instead of each point of emission. The firm can decide which sources are the least costly to eliminate. The level of pollution in the US has declined substantially as a result of government action.

Effect on Consumers
In all cases, the government's action internalize the costs. Supply decreases as a result and market prices rise and quantity decreases. How much price rises depends on the price elasticity of supply and demand. Consumers now have to pay the true cost of the goods they consume. They avoid the unpleasant conditions, health problems, and property damage and other harm associated with pollution.

External Benefits

In a competitive market, production will expand as long as the buyer's marginal benefit exceeds the marginal cost of producing another unit. Spillover or external benefits are not reflected in the price buyers pay (dollar signals to producers). Competitive markets are inefficient because some transactions for which the marginal benefits to buyers plus the additional benefits to third parties (external benefits) exceed the marginal opportunity cost of producing do not take place.

Education

People will enroll as long as the increase in income, benefits, and working conditions exceeds the cost of the education. External benefits include: increased pace of technological change, improved productivity of other workers, better public policy, increased knowledge in the next generation (parents as teachers), decreased crime. Provision of additional education would benefit society as MB to students plus MB to the rest of society > cost of providing the education.

Educational Policy

To get the efficient level of education, the government subsidizes education through scholarships or the sale of educational services at a price less than cost (in-state tuition; K-12). The subsidy raises the amount people are willing to pay. The price they are willing to pay now more accurately reflects the benefits from education recieved by the society as a whole. The demand curve shifts up and to the right. The price rises (but by less than the subsidy) and quantity increases.

Government intervention- low incomes

The operation of the competitive market does not guarantee that the distribution will be one people view as fair or equitable. Those who own few resources or resources that are not highly valued by producers will have low incomes and will not be able to afford "necessities." Sometimes the government tries to change the distribution of goods by changing the prices or quantities in the market; other times it taxes and redistributes income directly. Some form of government intervention include: Setting price ceilings (maximum prices) or price floors (minimum prices) Limiting the number of licenses or permits which the government requires to operate businesses. Establishing quotas of other output limitations

Price Ceilings (Maximums)
The government sets a maximum price below the market equilibrium price to help low income people buy the product. Firms can not sell the product at a price above that set by the government. Examples: rent control, oil and natural gas prices in the future, all goods during World War II and under Nixon. Proposals for: health care, energy

Effects of Price Ceilings

Producers don't find it profitable to produce as much; there's less available to consumers (Qs < Qe). The effect increases over time. There's a shortage (Qd >Qs). People devote resources to by-passing the regulations and illegal black markets develop. Efficiency declines as beneficial transactions do not take place (Qs to Qe). Development of black markets offsets some of the loss in efficiency but involves higher search costs.

The poor don't always benefit
The price can't rise and ration the good to those willing to pay the most. Alternatives are: Waiting in line (first come, first served) Seller prefersence Government-established priorities (categories) Black market (illegal sales) and bribes. Most alternatives do not favor the poor. Some (seller preference) result in the poor getting a smaller share of the diminished quantity.