Question

Suppose there are two countries in the world: Canada and the United States. Power plants in the United States mid-west burning high-sulphur coal contributes to the acidification of lakes in Canada. Explain by using a diagram, if the two countries do nothing to reduce pollution, then there is a loss in economic efficiency.

Answer 1

The quality of any body of surface or ground water is a function of either both natural influences and human influences.

Without human influences water quality would be determined by the weathering of bedrock minerals, by the atmospheric processes of evapo transpiration and the deposition of dust and salt by wind, by the natural leaching of organic matter and nutrients from soil, by hydrological factors that lead to runoff, and by biological processes within the aquatic environment that can alter the physical and chemical composition of water.

Declining water quality has become a global issue of concern as human populations grow, industrial and agricultural activities expand, and climate change threatens to cause major alterations to the hydrological cycle. Poor water quality has a direct impact on water quantity in a number of ways. Polluted water that cannot be used for drinking, bathing, industry or agriculture effectively reduces the amount of usable water within a given area. Water provides four types of important economic benefits: commodity benefits; waste assimilation benefits; aesthetic and recreational benefits; and fish and wildlife habitats. Individuals derive commodity benefits from water by using it for drinking, cooking and sanitation. Farms, businesses and industries obtain commodity benefits by using water in productive activities. These commodity benefits represent private good uses of water which are rivals in consumption (e.g. one person's or industry's water use precludes or prevents its use by others). Government policies and regulations that concentrate on improving market access and competition are important means for improving the productive and allocative efficiency of the commodity uses of water.

Water quantity and quality are adequate for most purposes. Extreme drought and floods are limited and serious pollution is confined to a few water systems. Considerable progress has been made in reducing some of the most serious pollution problems, especially in the areas of toxic chemicals and phosphorus loadings in Canada. Key manufacturing industries, such as pulp and paper, refining and aluminum, have significantly reduced their water pollution loadings in recent years. However, new toxic chemicals continue to challenge the ingenuity of pollution control authorities; and assigning responsibility for non-point sources to individual polluters remains difficult. Pollution problems are often "going underground" even as more Canadians come to rely on groundwater sources. Drought and flood control programmes, though successful, can create a false sense of security, and those who benefit from them bear few of their costs. Environmental decisions should better recognise economic realities and the potential for progress towards more cost-effective management of water resources. It is recommended that consideration be given to the following proposals:

— reduce the impact of agricultural activity on water quality, with special attention to nitrogen and phosphorus compounds, pesticides and suspended solids. This may require redirecting some funds traditionally devoted to water quantity issues and flood control. A combination of regulatory and nonregulatory, co-operative measures, based on direct contact with farmers, is likely to be the most fruitful;

— improve recognition and understanding of the relationship between water and economic variables, with: i) better data on expenditures, prices and financing; ii) more systematic analysis of the microeconomic conditions facing key water users; and iii) better understanding of the impact of agricultural, transportation and energy policies on water management;

— undertake a systematic review of subsidies for water supply and treatment infrastructure, and of water pricing policies, aiming at cost-effectiveness and long-term financing in the maintenance and upgrading of facilities. Subsidies for flood and drought control projects should also be critically reviewed in terms of their long-term impact on risk; and moves to full-cost pricing of water should be phased in to allow users, including farmers, to adapt to the new regime;

— enlarge the role of economic instruments in managing water resources. Water metering and conservation related price structures would both help conserve resources and finance new infrastructure. Other examples include accelerated capital cost allowances, joint ventures with industry for water technology development, cost-recovery arrangements for water research and taxes earmarked for the restoration of degraded sites.

In the question above, US is an negative externality that leads to decline the economic efficiency of Canada by burning high Sulphur Coal which results in acidification of lakes in Canada. This will again leads to increase in social cost of Canada that is called Cost of Pollution which is higher than the social optimum cost of canadian economy.

In the diagrame above, US is a negative externality that leads to increase the social cost of Canada by increasing social optimum cost by increasing the water pollution level in a country.