17.1 The Economic Rationale for Regulating Pollution
Pollution is a negative externality (i.e. 2O released from
Polluting firms who are profit maximizers do not regard a clean environment
as a scarce resource (fail to consider the full costs of using this resource
when producing their product).
When there are negative externalities, social marginal cost exceeds private
marginal cost because the act of production generates costs for society that
are not faced by the producer.
MC S MC + PEC
= Marginal External Cost
By producing where MC = P, the firm ignores the social cost and thus the
MB (Sarket price) < MC . S
Internalizing the externality: a process that results in a producer or
consumer taking account of a previously external effect.
The socially optimal level of output is at the quantity for which all marginal
costs, private plus external, equal the marginal benefit to society.
MEC is generally hard to calculate (i.e. pollution damage is often widespread
over hundreds of thousands of km and can affect millions of people.
It is impossible to produce goods/services without generating some
o The problem is to determine how much environmental damage to
allow or how much pollution abatement (reduction) to implement.
Zero environmental damage is generally not allocatively efficient.
The optimal amount of pollution abatement occurs where the MC of reducing
pollution is just equal to the MB from doing so o The socially optimal amount of pollution abatement implies a positive
amount of pollution.
o Measured on a graph:
X-axis: Pollution abatement (%)
Y-axis: Dollars per Unit
Marginal cost of abating pollution is often small at low levels of abatement
but rises steeply after some point.
Marginal benefit curve slopes downward since the added benefit of reducing
pollution by one unit will continually decrease (i.e. a bit of cleaning in a very
dirty environment will have a high benefit but a bit of cleaning in a very clean
environment will have little benefit).
Pollution-control authorities face three problems when trying to obtain the
optimal amount of pollution abatement:
o The private sector will not by itself create a market in pollution
control (government must intervene).
o The MB and MC curves are not usually observable (optimal level will
be hard to estimate).
o The available techniques for regulating pollution are themselves
17.2 Pollution-Control Policies
There are three types of policies designed to bring about the optimal level of
o Direct controls
o Emission taxes
o Tradable pollution permits
Direct Controls (command-and-control)
o Used most often in Canada and the U.S.
o Can include:
Requiring certain techniques to be used to reduce pollution.
Standards to be followed (maximum amounts of pollution
Prohibition of certain polluting behaviours.
New cars must all meet the standards set out by the
Emissions/km must be less than specified amounts.
Devices used in coal-fired electric plants that reduce
sulphur dioxide emissions.
The government has banned leaded gasoline (gradually
o Problems: Direct pollution controls are not productively efficient because
the total cost of achieving a given amount of pollution
abatement is not maximized.
Pollution is being abated efficiently when the MC of
pollution abatement is the same for all firms.
Direct pollution controls are usually inefficient because they do
not minimize the total cost of a given amount of pollution
I.e. different firms may have different costs associated
with reducing the same amount of pollution.
Monitoring and enforcement of direct pollution controls are
costly, and this costliness reduces the effectiveness of the
If the chances of being caught and the penalties are small, the
direct controls may have little effect.
Some direct controls have undesirable effects.
I.e. the required average level of fuel efficiency that was
required in the US.
o The mere existenc