Question

Environmental Economics (10)

Nobody likes pollution (or crime, or accidents)! But economists, as they so often do, bring a different perspective to the issue of pollution. Assume that a paper plant dumps the chemicals it uses in making paper into the river it is located next to, polluting the river for downstream users. The paper plant operates in a perfectly competitive market (the price it charges for its products equals its average total cost of production, not counting the costs of pollution, and it earns only a normal profit on its business.)

1. Who loses and who gains from the pollution caused by this plant? (5)

2. Explain why the economist says that it doesn’t make sense to reduce the amount of pollution to zero. What is the “optimal” amount of pollution? (5)

Answer 1

Pollution degrades the environment and in unregulated market, over production results in excessive pollution. Hence this can be considered as a negative externality where the creator of an externality is not paying for the social cost which it is imposing on the society

1) There is a paper plant that is dumping the chemicals into the river. Now it is the downstream users who are losing because the paper plant is not incorporating the cost of pollution it is created. The paper plant is gaining because currently there is no regulation on its operations and it is not paying for the cost it is imposing on the downstream users. These users have a reduction in their benefit because the river water is getting polluted and is no longer as useful as it was.

2) Zero pollution is not an optimal choice because this would not be possible. Firm will find it optimal to shut down operations and leave because the cost of abating the pollution down to zero will be too high. An optimal amount of production of pollution should be the one where marginal cost of abatement of pollution is equal to the marginal damage. This also means marginal social benefit equals marginal social cost of creating pollution.