Using Markets to Reduce Pollution

Economic Concepts	Environmental Context
Markets incorporate incentives to reduce costs	Clean air markets
Externalities
Markets
Marginal analysis

National Content Standards Addressed:

Standard 2: Effective decision making requires comparing the additional costs of alternatives with the additional benefits. Most choices involve doing a little more or a little less of something; few choices are all-or-nothing decisions.

Standard 4: People respond predictably to positive and negative incentives.

Standard 5: Voluntary exchange occurs only when all participating parties expect to gain.

Standard 7: Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce goods and services.

Standard 16: There is an economic role for government to play in a market economy whenever the benefits of a government policy outweigh its costs.

Key Points

1. Even after reaching a consensus agreement that we want (a particular level of) environmental quality, economic reasoning confronts us with the reality that the resources to accomplish that goal are scarce.
   • Review: All decisions about resource use bear opportunity costs.
2. Reaching desired levels of environmental quality is often difficult because of the existence of externalities.
   • Externalities are costs or benefits that aren’t captured in exchange.
     • Positive externalities: benefits that accrue to people who do not bear the costs of producing the benefits.
       • Examples: Mosquito spraying, childhood vaccinations
   • Negative externalities: costs imposed on people who do not share in the benefits.
     • Examples: Pollution, smoking in public, loud music
3. Limiting externalities is often considered an appropriate rationale for government intervention in market economies.
   • Review (from lesson 5): progression of thought in environmental movement
     • Conventional, “command and control” methods used to reach desired levels include:
       • Setting standards (with or without BAT designations), and imposing fines for non-compliance.
       • Permitting
       • Taxation
       • Self-regulation
     • Recent increase in willingness to try market-oriented policies that can accomplish goals at lower cost.
4. The appropriate guideline for evaluation of government pollution policies is that the benefits of the government’s actions outweigh the costs. (See standard 16)
   • Review: the relevant benefits and costs are marginal
   • Review: optimal solutions occur at the point where MB = M

   Case Study: Sulfur Dioxide pollution – a government market initiative

5. The history of efforts to reduce sulfur dioxide pollution in the United States illustrates how the use of markets helps to lower the cost of reaching environmental goals.
   • 1970s goal: treat perceived threat of pollution-induced acid rain by reducing sulfur dioxide emissions in the NE corridor by 50%.
     • Pollution source: coal-fueled electric generating plants
   • 1987-90: Command and control: all electricity generating plants to reduce emissions by 10%
     • Constraint: variety of factors affect the cost of reducing sulfur dioxide emissions:
       • Age of equipment
       • Skill of work force in fine-tuning the carbon-oxygen burn
       • Sulfur level in coal
   • 1990: Concern with differences in cost led to experiment with tradable pollution permits
     • mechanics of the SO₂ market
       • EPA site for Clean Air Market: http://www.epa.gov/airmarkets/arp/index.html
     • history of market for SO₂ permits:
       • Reasons for changes in price
       • Opening market to buyers outside the electricity industry
       • how the rising price of permits is an indicator of increased environmental quality

   Activity: Pollution Permit Problem

6. Answering the passionate objector
   • As licenses to pollute, permits are morally reprehensible. (“It works, but I don’t like it.”)
   • ” Polluters will pass the costs to consumers.
   • ” The permit program reduces the search for better methods to reduce and/or clean up emissions.
7. The major remaining issue in the pollution permit debate is the concentration effect in which some areas and some populations get a disproportionate share of the benefits and others bear a disproportionate share of the costs.
   • Attempt to correct disproportions through “bubble” policy acknowledges the legitimacy of this concern.
   • Importance of considering that concentration is occurring at lower level, and that lower opportunity cost means resources released to meet other goals.
8. Other pollution markets
9. Carbon Sequestration – a business initiated market
   • Concerns about global warming have led to privately initiated, speculative markets for carbon sequestration.
   • Two technological conditions necessary for this market are the same as those for the SO2 market examined in the activity: 1) the ability to sequester the substance (carbon), and 2) the ability to measure the amount
     • Technology currently exists with carbon in land but not in oceans.
   • The speculative market is based on anticipation that EPA will mandate reduction of carbon dioxide emissions as a measure to combat global warming.
10. Conclusion: the same incentives that lead markets to produce more goods and services for lower cost can help us to achieve greater environmental benefit at lower cost.