Question

What is cost effectiveness analysis? Why might we focus on cost effectiveness instead of efficiency?

What is the relationship between cost effectiveness and efficiency?

If an allocation of pollution control across firms is cost-effective – meaning that it is the least cost way of achieving the total level of pollution control done by the firms – what must be true of the allocation?

Why is an emissions tax cost (or cap-and-trade scheme) effective?

In general, why is a technology standard not cost effective? In general, why is a uniform emissions standard not cost effective? Could a uniform emissions standard ever be cost effective? Explain.

Why does tax provide stronger incentives for technological innovation and adoption than an emissions standard? Why does a CAT scheme provide slightly weaker incentives than a tax?

Is a technology standard a good way to promote technological innovation?

Would we ever want to subsidize R&D directly? Why?

If our goal is to constrain emissions, would it be better to use an emissions tax or a CAT scheme in a rapidly growing economy? What about in an economy with high inflation?

Compare the impact of an emissions tax and a CAT scheme in an economy experiencing rapid technological change which is bringing down the cost of abating emissions.

Identify one situation in which a command-and-control policy might be preferred to a market-based policy. Explain your answer.

What are pollution hotspots? Explain what the uniform mixing assumption is and why violations of that assumption can potentially be problematic for market-based policies. How can these policies be adjusted to mitigate this issue?

U.S. Sulfur Dioxide Trading Program

T/F. The U.S. Acid Rain Program (Title IV of the Clean Air Act Amendments of 1990) was successful at reducing pollution, but ultimately the costs of the program exceeded the benefits. The greatest benefits from the program came from reducing ecosystem acidification.

Answer 1

• Cost Effectiveness
  • Distinguish cost effectiveness from efficiency
  • Cost effectiveness - achieving a given target at the minimum possible cost
  • Efficiency is more than cost effectiveness. Cost effectiveness is necessary, but efficiency has to also balance marginal benefit with marginal cost. In the context of our model of pollution control, the industry MAC must reflect the minimum possible marginal cost at each level of emission reduction, and then efficient level of emissions would be the level that equates MAC=MD. Let us discuss cost effectiveness in this section.
  • Suppose a city decides to reduce air pollution by 50%. A number of alternatives exist to achieve this target, like reducing auto emissions, reducing factory emissions, or a combination of the two.
  • Benefit of each alternative in this case (benefit of reducing air pollution by 50%) is the same, no matter which alternative is chosen. This allows us to focus on how to minimize the cost of reducing pollution.
  • The objective of cost effectiveness is to choose the alternative that achieves the given target at the minimum cost possible.
  • The Equimarginal Principle of Cost Effectiveness
    • To minimize the total cost of abating pollution by a given level, allocate abatement among multiple sources such that marginal costs of abatement are equalized.
    • Discuss an example to show the equimarginal principle: MC_a=MC_b=... across all plants (subscripts a and b denote different plants).
    • Trade-off between Market Goods and Environmental Quality
    • Production possibility frontier of two goods: market goods and environmental quality (draw a PPF)
    • The more the production of market goods, the lower the environmental quality, given a state of technical know-how
    • Values placed by a society on environmental quality and on market goods (the social indifference curve, derived from social welfare function) determine the choice of the society where to locate on the PPF
    • Value of environmental quality vis-a-vis market goods may differ among societies according to educational level, income, and information.
    • A short-run choice can affect long-run choices between environmental quality and market goods
      • Excessive emphasis to market goods in the short run may damage the assimilative capacity of the environment and thus future productive capability of an economy (this shifts the PPF inwards).
    • Linkage Between Economy and Environment
    • Draw a box diagram to show linkages between Nature and economy.
    • Nature provides raw materials and energy to the economy. Economy uses the resources to produce goods that are then consumed. During production and consumption processes, residuals are emitted to Nature.
    • Environmental economics is the study of the flow of residuals (see the box diagram) and its impact in the natural world.
    • According to the First Law of Thermodynamics (also known as the Law of Conservation of Matters), matters only change in shape, size, or phases, the total weight is conserved. What goes in must come out. Thus, the total weight of raw material and energy inputs to economy must be balanced by the total amount of residuals flowing to the environment.
    • Simple Model of Pollution Control

    • Marginal Damage Function (MD)

    • Pollution causes many types of damages. The benefit of pollution control is a reduction in damages of lives and properties.
    • Let us define marginal damage. Marginal damage is the additional damage caused by an additional unit of emission.
      • Example:
        • If total damages increase from $30,000 to $35,000 when emissions increase from 10 tons per week to 12 tons per week, marginal damage is $2,500 per ton. [($35,000-$30,000)/(12 tons-10 tons)]=$2,500 per ton.
    • Marginal damage function is a relationship between quantity of emissions and the damage caused by emissions. Draw an upward-sloping marginal damage curve.
    • The curve assumes that marginal damage increases with increasing emissions.
    • There is a threshold below which marginal damage is zero.
    • The area below the function measures total damage.
    • Marginal damage is a time-specific function; it may shift with time because of changes in natural environment.
    • Let us focus on marginal damage from a non-cumulative pollutant (a pollutant which does not accumulate over time).
    • The marginal damage function is a population-specific function; it may shift with an increase in the number of people exposed to the pollutants.

    • Marginal Abatement Cost Function (MAC)

    • This function denotes the additional cost of achieving one more unit decrease in level of emissions.
    • It is sloping upward to the left. Draw a marginal abatement cost curve.
    • The higher the emission reduction, the greater the marginal abatement cost.
    • At its right end, the curve starts from the maximum level of emissions with no abatement efforts, i.e., from the uncontrolled level of emissions.
    • This function reflects the minimum costs of achieving different levels of emission reduction. In other words, pollution abatement is being carried out in a cost-effective manner. We will later discuss in more length the equimarginal principle of achieving a target in the least cost, or cost effective, manner.
    • Note that there is always an upper limit on abatement costs, which is the cost of stopping operations of the polluting plant (zero emission).
    • Area below the curve measures total abatement costs of achieving a reduction in emissions.
    • Different sources, i.e., polluters, may have different MAC functions because of different technology of abatement available to them.
    • For the same source, its MAC function may shift with time periods because of improvement in technology of pollution control.
    • Aggregate marginal abatement function of the industry is the horizontal summation of the MACs of individual firms (just as is the industry supply, or the marginal cost of production).

    • Efficient Level of Emission

    • Let us assume that MD and MAC have been evaluated from the perspective of society.
    • MD can be interpreted as the marginal benefit of reducing emissions (damages saved), and MAC is the marginal cost of reducing emissions.
      • That is, they are social marginal benefits and social marginal costs of reducing pollution.
      • The efficient level of emissions (the level that maximizes social net benefits) would then be where MD and MAC are equal (MAC=MD), the point of intersection of MAC and MD. Explain graphically.
    • Alternatively, we can interpret both MD and MAC as costs.
      • No matter which level of emissions a society chooses, it has to incur costs on bringing down emissions to that level, and at that level, there are some damages still remaining. At any level of emissions, therefore, the society incurs abatement costs plus costs of damages.
      • The society would be efficient if it chooses that level of emissions which is associated with the minimum possible total of abatement costs and damages.
      • The area below the MAC is total abatement costs and the area below the MD is total damages. Show in the graph that only at the intersection of the two curves (MAC and MD), the sum of the two costs is minimum.
    • Here, we ignored costs of enforcing emission standards.
      • Sources (polluters) may not follow the chosen emission standards voluntarily, and the society may have to incur costs on enforcement. If so, enforcement costs should be included while deciding the efficient level.
      • The more emissions polluters are asked to cut back, the more expensive it gets for them to cut back each additional unit of emissions. (This is because of the increasing MAC).
      • Therefore, polluters are more likely to cheat on cutbacks when the efficient level involves larger emission reductions.
      • Consequently, the marginal cost of enforcing cutbacks is also likely to increase with mandating higher and higher levels of reductions of emissions. That is, marginal enforcement cost would be increasing with increasing abatement.
      • Thus, there are two types of costs involved in achieving a reduction in emissions: costs incurred by sources for abatement and costs incurred by the pollution control authority for enforcing the abatement target. In other words, the total marginal cost (TMC) of emission reduction is the sum of MAC and marginal enforcement cost (MEC). TMC=MAC+MEC. Show in a graph.
      • Note that the gap between the TMC and MAC increases progressively with additional reductions (as one moves to the left along the MAC), reflecting increase in MEC with increase in emission reductions.
      • Efficient emission level is then given by the intersection of the TMC and the MD curves.
      • This efficient level would be lower than the previously determined efficient level with no enforcement costs, implying that the society should be willing to accept lower emission reductions for the sake of enforceability of emission standards.