ECON-1006EL Chapter Notes - Chapter 17: Allocative Efficiency, Marginal Cost, Economic Equilibrium
23 May 2018
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Chapter 17: The Economics of Environmental Protection
Definitions
Internalizing the externality
A process that results in a producer or consumer taking account of a
previously external effect
Tradable pollution permits
Rights to emit specific amounts of specified pollutants that private firms
may buy and sell among themselves. The total quantity of permits is set
by government policy.
Key Points
• The socially optimal level of output is such that the social marginal cost equals the social
marginal benefit.
• Zero environmental damage is generally not allocatively efficient.
• Pollution is being abated efficiently when the marginal cost 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 abatement.
• Monitoring and enforcement of direct pollution controls are costly, and this costliness
reduces the effectiveness of the controls.
• Emissions taxes lead profit-maximizing firms to abate pollution in a cost-minimizing
manner. If the tax is set equal to the marginal external cost of the pollution, the
externality will be fully internalized and the allocative efficient amount of pollution
abatement (and output) will be produced.
• A disadvantage with emissions taxes is that information necessary to determine optimal
tax rate is often unavailable.
• Will tradable pollution permits, profit-maximizing firms will reduce pollution until their
marginal abatement costs equal the price of pollution permits. The costs of a given
amount abatement will be minimized.
• In the market for pollution permits, the quantity is set by government policy. Given that
quantity, the equilibrium price is determined by firms’ demand for pollution permits.
• Improvements in abatement technology will lead to a reduction in the demand for
emissions permits and thus a reduction in their equilibrium price. The total cost of a given
amount of pollution abatement will still be minimized.
• When the government does not know firms; abatement technologies, emissions taxes
impose a certain per unit cost on polluting firms but result in an uncertain amount of
pollution abatement.
• When the government does not know firms’ abatement technologies, a cap-and-trade
system ensures a certain quantity of pollution abatement but imposes an uncertain cost on
polluting firms.
Lecture Notes
• For 80% to 81% pollution cost a lot
• For 5% to 6% pollution cost a little
• Optimal amount of pollution (eq point) (diagram 17-2)
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