1.4.4
Policy for Negative Externalities
Environmental Regulation
Environmental Regulation
Traditionally, environmental regulations in the U.S. have taken the form of 'command-and-control regulation.'
Command and control regulation defined
Command and control regulation defined
- Environmental regulations which specify allowable quantities of pollution and which also may detail which pollution-control technologies companies must use, fall under the category of command-and-control regulation.
- In effect, command-and-control regulation requires that firms increase their costs by installing anti-pollution equipment. Thus, firms are required to account for the social costs of pollution in deciding how much output to produce.
U.S. context
U.S. context
- When the United States started passing comprehensive environmental laws in the late 1960s and early 1970s, a typical law specified to companies how much pollution their smokestacks or drainpipes could emit and imposed penalties if companies exceeded the limit.
- In 1970, the Federal government created Environmental Protection Agency (EPA) to oversee all environmental laws. In the same year, Congress enacted the Clean Air Act to address air pollution. Just two years later, in 1972, Congress passed and the president signed the far-reaching Clean Water Act. These command-and-control environmental laws have been largely responsible for America’s cleaner air and water in recent decades.
Command and control regulation drawbacks
Command and control regulation drawbacks
- Command-and-control regulation offers no incentive to improve the quality of the environment beyond the standard set by a particular law. Once firms meet the standard, polluters have zero incentive to do better.
Command and control regulation drawbacks
Command and control regulation drawbacks
- Second, command-and-control regulation is inflexible. It usually requires the same standard for all polluters, and often the same pollution-control technology as well.
- This means that command-and-control regulation draws no distinctions between firms that would find it easy and inexpensive to meet the pollution standard—or to reduce pollution even further—and firms that might find it difficult and costly to meet the standard.
- Firms have no reason to rethink their production methods in fundamental ways that might reduce pollution even more and at lower cost.
Command and control regulation drawbacks
Command and control regulation drawbacks
- Legislators write the command-and-control regulations, and so they are subject to compromises in the political process.
- Existing firms often argue (and lobby) that stricter environmental standards should not apply to them, only to new firms that wish to start production. Consequently, real-world environmental laws are full of fine print, loopholes, and exceptions.
Market-Oriented Pollution Charges
Market-Oriented Pollution Charges
Market-oriented environmental policies create incentives to allow firms some flexibility in reducing pollution.
Market-Oriented Pollution Charges
Market-Oriented Pollution Charges
- The three main categories of market-oriented approaches to pollution control are:
- pollution charges;
- marketable permits; and
- better-defined property rights.
- All of these policy tools which we discuss, below, address the shortcomings of command-and-control regulation - albeit in different ways.
Pollution charges
Pollution charges
- A pollution charge is a tax imposed on the quantity of pollution that a firm emits.
- A pollution charge gives a profit-maximizing firm an incentive to determine ways to reduce its emissions—as long as the marginal cost of reducing the emissions is less than the tax.
Marketable permits
Marketable permits
- When a city or state government sets up a marketable permit program (e.g. cap-and-trade), it must start by determining the overall quantity of pollution it will allow as it tries to meet national pollution standards.
- Then, it divides a number of permits allowing only this quantity of pollution among the firms that emit that pollutant. The government can sell or provide these permits to pollute free to firms.
Marketable permits
Marketable permits
- Now, add two more conditions. Imagine that these permits are designed to reduce total emissions over time. For example, a permit may allow emission of 10 units of pollution one year, but only nine units the next year, then eight units the year after that, and so on down to some lower level. In addition, imagine that these are marketable permits, meaning that firms can buy and sell them.
- The total quantity of pollution will decline. However, buying and selling the marketable permits will determine exactly which firms reduce pollution and by how much.
- With a system of marketable permits, the firms that find it least expensive to do so will reduce pollution the most.
Better-defined property rights
Better-defined property rights
- A clarified and strengthened idea of property rights can also strike a balance between economic activity and pollution.
- Ronald Coase (1910–2013), who won the 1991 Nobel Prize in economics, offered a vivid illustration of an externality: a railroad track running beside a farmer’s field where the railroad locomotive sometimes emits sparks and sets the field ablaze. Coase asked whose responsibility it was to address this spillover.
Better-defined property rights
Better-defined property rights
- Coase pointed out that one cannot resolve this issue until one clearly defines property rights—that is, the legal rights of ownership on which others are not allowed to infringe without paying compensation.
- if either the farmer or the railroad has a well-defined legal responsibility, then that party will seek out and pay for the least costly method of reducing the risk that sparks will hit the field. The property right determines whether the farmer or the railroad pays the bills.
1Microeconomics
1.1Competitive Markets: Demand & Suply
1.2Elasticity
1.3Government Intervention
1.4Market Failure
1.4.1Types of Market Failure
1.4.2Introduction to Externalities
1.4.3Negative Externalities
1.4.4Policy for Negative Externalities
1.4.5Positive Externalities
1.4.6The Deadweight Welfare Loss of Externalities
1.4.7Case Study - The Externalities of Education
1.4.8Public Goods & the Free-Rider Problem
1.4.9Asymmetric Information
1.4.10End of Topic Test - Market Failure
1.4.11Application Questions - Market Failure
1.5HL: Theory of the Firm & Market Structures
2Macroeconomics
2.1The Level of Overall Economic Activity
2.2Aggregate Demand & Aggregate Supply
2.2.1The Aggregate Demand Curve
2.2.2Components of Aggregate Demand
2.2.3Shape of the Aggregate Demand Curve
2.2.4Shifts in Aggregate Demand
2.2.5IB Multiple Choice - Aggregate Demand
2.2.6Short & Long-Run Aggregate Supply
2.2.7Alternative Models of LRAS
2.2.8Equilibrium in the AD-AS Model
2.2.9Output Gaps & the AD-AS Model
2.3Macroeconomic Objectives
2.3.1Introduction to Unemployment
2.3.2Limitations of Unemployment
2.3.3Types of Unemployment
2.3.4Causes & Impact of Unemployment
2.3.5Defining Inflation
2.3.6Measuring Inflation
2.3.7Use of Index Numbers
2.3.8The Consumer Price Index
2.3.9Consequences of Inflation
2.3.10Causes of Inflation
2.3.11Inflation & Unemployment Tradeoff
2.3.12The Short-Run Phillips Curve
2.3.13The Long-Run Phillips Curve
2.4Economic Growth, Poverty & Inequality
2.5Fiscal Policy
2.6Monetary Policy
2.7Supply-Side Policies
3The Global Economy
3.1International Trade
3.2Exchange Rates
3.3The Balance of Payments
3.4Economic Integration
3.5Terms of Trade
3.6Economic Development
3.7The Role of Domestic & International Factors
3.8The Role of International Trade
3.9The Role of Foreign Aid
Jump to other topics
1Microeconomics
1.1Competitive Markets: Demand & Suply
1.2Elasticity
1.3Government Intervention
1.4Market Failure
1.4.1Types of Market Failure
1.4.2Introduction to Externalities
1.4.3Negative Externalities
1.4.4Policy for Negative Externalities
1.4.5Positive Externalities
1.4.6The Deadweight Welfare Loss of Externalities
1.4.7Case Study - The Externalities of Education
1.4.8Public Goods & the Free-Rider Problem
1.4.9Asymmetric Information
1.4.10End of Topic Test - Market Failure
1.4.11Application Questions - Market Failure
1.5HL: Theory of the Firm & Market Structures
2Macroeconomics
2.1The Level of Overall Economic Activity
2.2Aggregate Demand & Aggregate Supply
2.2.1The Aggregate Demand Curve
2.2.2Components of Aggregate Demand
2.2.3Shape of the Aggregate Demand Curve
2.2.4Shifts in Aggregate Demand
2.2.5IB Multiple Choice - Aggregate Demand
2.2.6Short & Long-Run Aggregate Supply
2.2.7Alternative Models of LRAS
2.2.8Equilibrium in the AD-AS Model
2.2.9Output Gaps & the AD-AS Model
2.3Macroeconomic Objectives
2.3.1Introduction to Unemployment
2.3.2Limitations of Unemployment
2.3.3Types of Unemployment
2.3.4Causes & Impact of Unemployment
2.3.5Defining Inflation
2.3.6Measuring Inflation
2.3.7Use of Index Numbers
2.3.8The Consumer Price Index
2.3.9Consequences of Inflation
2.3.10Causes of Inflation
2.3.11Inflation & Unemployment Tradeoff
2.3.12The Short-Run Phillips Curve
2.3.13The Long-Run Phillips Curve
2.4Economic Growth, Poverty & Inequality
2.5Fiscal Policy
2.6Monetary Policy
2.7Supply-Side Policies
3The Global Economy
3.1International Trade
3.2Exchange Rates
3.3The Balance of Payments
3.4Economic Integration
3.5Terms of Trade
3.6Economic Development
3.7The Role of Domestic & International Factors
3.8The Role of International Trade
3.9The Role of Foreign Aid
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