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Lecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail: [email protected] Giovanni Marin Environmental Economics - Lecture 3 1 / 22

Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

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Page 1: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Lecture 3Pollution targets

Environmental Economics, Politecnico di Milano, Academic Year2015-2016

Giovanni Marin

IRCrES-CNR, Milanoe-mail: [email protected]

Giovanni Marin Environmental Economics - Lecture 3 1 / 22

Page 2: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Book paragraphs for this lecture: 5.1, 5.2, 5.3, 5.4, 5.5, 5.6

Giovanni Marin Environmental Economics - Lecture 3 2 / 22

Page 3: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Pollution targets

� In thinking about pollution policy, economists are interested in twoissues:

1. How much pollution should there be?2. Given that some target level of pollution has been chosen, what is the

best (cost-effective) method of achieving that level?

� Today we focus on the first question, i.e. “what should be thetarget level of pollution”?

Giovanni Marin Environmental Economics - Lecture 3 3 / 22

Page 4: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Modelling framework

� The target level of emissions (or pollution) resulting from any analysisdepends on the modelling framework employed, particularly itsbreadth

� Breadth might refer to geographical or political scope (e.g. carbonemissions from US alone or the rest of the world)

� It may also refer to the framework used: partial equilibrium or generalequilibrium analysis

� A partial equilibrium approach looks at a single market (e.g.electricity) or activity, in isolation from the rest of the economicsystem

� A general equilibrium framework looks at the interactions of all theelements of the entire economic system

Giovanni Marin Environmental Economics - Lecture 3 4 / 22

Page 5: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Modelling pollution within an economic efficiencyframework

� Analyse what the criterion of economic efficiency has to say aboutdetermining pollution targets

� Economic activity generates emissions flows that impose pressures onthe environment

� The extent to which these pressures generate impacts that areassociated with subsequent damage depends on several things ⇒ e.g.the location of the environmental receptor, the assimilative capacityof the receptor, people’s tastes, etc.

� Some proportion of the emission flows is quickly absorbed andtransformed by the environment into harmless forms

� Some proportion of pressures will, in any time interval, remainunabsorbed or untransformed (e.g. radioactive material)

Giovanni Marin Environmental Economics - Lecture 3 5 / 22

Page 6: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Pollution flows, pollution stocks and pollution damage

� Flow-damage pollution (M) occurs when damages result only fromthe flow of residuals; that is, the rate at which they are beingdischarged into the environmental system

� By definition, for pure cases of flow-damage pollution (e.g. noise orlight), the damage will immediately drop to zero if emission flows stop

� Stock-damage pollution (A) describes the case in which damagesdepend only on the stock of the pollutant in the relevantenvironmental system at any point in time (e.g. concentration of CO2in 1998)

� For a stock of the pollutant to accumulate, it is necessary that theresiduals have a positive lifespan and that emissions are being producedat a rate which exceeds the assimilative capacity of the environment(e.g. heavy metals)

Giovanni Marin Environmental Economics - Lecture 3 6 / 22

Page 7: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Pollution flows, pollution stocks and pollution damage

At = At−1α +Mt

� α is the assimilative capacity� α = 0 ⇒ At =Mt ⇒ flow pollutant� α = 1 ⇒ no assimilation ⇒ irreversible growth in the stock

Giovanni Marin Environmental Economics - Lecture 3 7 / 22

Page 8: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Pollution flows, pollution stocks and pollution damage

� Most important pollution problems have the attribute of astock-damage pollution effect being present

� Besides the intuitive impact upon human health, agriculture, etc.pollution stocks may have an impact also on the assimilative capacityof the environment

� Nonetheless, from a regulatory perspective is difficult to regulatestocks, but it is often possible only to act on flows

� If M=pollution flow, A=pollution stock and D=pollution damage,then we have two damage functions:

� Flow-damage pollution: D = D(M)� Stock-damage pollution: D = D(A)

Giovanni Marin Environmental Economics - Lecture 3 8 / 22

Page 9: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Expected lifetime of pollutants

Pollutant Atmospheric lifetime

Carbon dioxide (CO2) 5 to 200 yearsMethane (CH4) 12 yearsNitrous oxide (N2O) 114 yearsCFC-11 45 yearsHFC-23 260 yearsCF4 more than 50k yearsSulphur 0.01 to 7 daysNOx 2 to 8 days

Giovanni Marin Environmental Economics - Lecture 3 9 / 22

Page 10: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

The efficient level of pollution emissions

� We now investigate how pollution targets can be set using aneconomic efficiency criterion

� Zero pollution is not efficient, except in special circumstances� Polluting activities also generate economic values� Generally the marginal damage function starts from low values and is

finite

� If producers of goods and services act rationally, they will selectprivate cost-minimizing techniques of production, which generateharmful emissions as by-product (externality)

� Production yields a benefit to the producer (polluter) and a damageto the pollutee (i.e. the subject which suffers from the externality)

� Damages can be thought of as a negative (adverse) externality� In many cases the externality happens to be a public bad, in that once

it has been generated, no one can be excluded form suffering itsdamaging effects

Giovanni Marin Environmental Economics - Lecture 3 10 / 22

Page 11: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Efficient emissions: damages and benefits

� With both benefits and costs, economic decisions about theappropriate level of pollution involve the evaluation of a trade-off:stricter pollution targets will not only generate benefits for thepollutee but will also generate costs for the producer/polluter

� The trade-off is optimized at the point where the marginal benefitsarising from reduced pollution damage fall to a level equal to themarginal cost from reducing pollution

� Recall the MB =MEC condition for an efficient level of externality

Giovanni Marin Environmental Economics - Lecture 3 11 / 22

Page 12: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Costs and benefits of pollution

� An efficient level of flow pollution M is the one for which net benefitsare maximized

� Net benefits ⇒ B(M) −D(M)� Condition ⇒ dB(M)/dM = dD(M)/dM� If a market for emissions existed, in equilibrium we would have a

positive price attributed to pollution

� Shadow price of pollution ⇒ µ∗ = dB(M)/dM = dD(M)/dM

Giovanni Marin Environmental Economics - Lecture 3 12 / 22

Page 13: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Total benefits and damages from pollution

M

B(M)

D(M)

Max B(M)-D(M)

M*

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Page 14: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Marginal benefits and damages from pollution

M

MB(M)

Max B(M)-D(M)

M*

MD(M)

μ*

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Page 15: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Pollution and abatement

� When discussing the issue of externalities, the amount of externaldamages was assumed to depend directly on the production of good X

� A direct link was assumed to relate production of X with emissions M

� It is sometimes more convenient to look directly at the level ofemissions generated rather than at the production of X

� This means that we can look at abatement of emissions rather thanat emissions ⇒ Abatement =MMAX −M

� This means that B(M) = B(MMAX −Abatement) andD(M) = D(MMAX −Abatement)

Giovanni Marin Environmental Economics - Lecture 3 15 / 22

Page 16: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Pollution and abatement

� The benefits from pollution arising to the polluter can be also seen asthe opportunity cost of abating pollution

� Abatement of pollution is costly for the polluter:

1. Purchase and installation of pollution control equipment2. More radical changes of the production process towards cleaner

production processes3. Reduction in the level of production

� For each additional unit of emission reduction, the polluter maydecide to put into practice any of the three strategy

� The abatement cost curve (that is a function of the abatement)describes the most efficient way of abating emissions

� Least costly abatement options come first, most expensive optionscome last ⇒ marginal abatement costs are increasing in abatement

Giovanni Marin Environmental Economics - Lecture 3 16 / 22

Page 17: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Marginal cost of abatement of CO2 emissions

Source: McKinsey & C

Giovanni Marin Environmental Economics - Lecture 3 17 / 22

Page 18: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Optimal abatement

Abatement=MMAX-M

Marginal cost of abatement => MB(M)

Abatement s.t. M=M*

Marginal benefit of abatement => MD(M)

μ*

M=MMAX

Giovanni Marin Environmental Economics - Lecture 3 18 / 22

Page 19: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Optimal abatement with two polluting firms

� Assume there are two firms with different functions for the marginalcosts of abatement

� Optimality still requires that the (aggregate) marginal abatement costfunction equals the function that describes the marginal benefit ofabatement

� This means that an optimal abatement level with more than onepolluter requires that the marginal cost of abatement is the same forall firms, even though their abatement cost functions are different

� Abatement will not be distribute equally across all firms but firmswith lower abatement cost functions should abate more than firmswith greater abatement cost functions

Giovanni Marin Environmental Economics - Lecture 3 19 / 22

Page 20: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Aggregate marginal abatement costs

Abatement

Aggregate marginal cost of abatement

Optimal abatement

Marginal benefit of abatement

μ*

Giovanni Marin Environmental Economics - Lecture 3 20 / 22

Page 21: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Aggregate marginal abatement costs

Abatement Optimal abatement

μ*

Marg abatement cost of A

Marg abatement cost of B

Optimal marginal abatement cost

Abatement of A

Abatement of B

Giovanni Marin Environmental Economics - Lecture 3 21 / 22

Page 22: Lecture 3 Pollution targets - AltervistaLecture 3 Pollution targets Environmental Economics, Politecnico di Milano, Academic Year 2015-2016 Giovanni Marin IRCrES-CNR, Milano e-mail:

Setting pollution standards with stock pollution

� With stock pollution, the damage depends on the stock of pastemissions, net of the assimilation of pollution

� As it is not (generally) possible control the stock of pollution, but justthe flow, the identification of the optimal target needs to account forthe inter-temporal dimension of the problem

� With positive interest rate and strictly assimilation α smaller than one(remember, At = At−1α +Mt), a steady state level of pollution existsthat guarantees optimality

� Optimality also requires to compute the optimal path of convergencetowards the steady state...

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