ECOS3013 ENVIRONMENTAL ECONOMICS

Transcription

1 ECOS3013 ENVIRONMENTAL ECONOMICS Lecture 3: Market Failure Markets are exchange institutions which ensure the efficient organisation of economic activity. Market failure occurs when private decisions based on prices do not generate a social welfare maximising allocation of resources. First Theorem of Welfare Economics: Markets will result in Pareto optimal allocation of resources if a complete set of markets exists with well defined property rights - Property rights are sets of institutions which define the rights and limitations of ownership/ usage e.g private/ collective/ limited - Government policy has the ability to change the nature of institutions/ property rights via restriction of right to access a public resource Well-defined property rights - Exclusive (Rival): all benefits and costs accrue only to the owner directly e.g no DWL - Transferable: property rights can be exchanged in voluntary markets - Excludable: rights that can reasonably exclude use by certain agents - Enforceable: legal institutions exist to guarantee the property right - And are specified, universal and divisible Well defined property rights facilitate efficient allocation by allowing resource owners can transfer the rights to alternative agents who place a higher value on the resource. Failure to satisfy any of the above conditions means failure to achieve social welfare maximising allocation of resources. Types of goods RIVAL NON-RIVAL EXCLUDABLE Pure private goods (use is exclusive to owner and consumption of one will reduce consumption ability of another) e.g icecream which produce no positive or negative externalities Congestible resources (consumption by one does not affect another) e.g cable TV or sunsets NON-EXCLUDABLE Open-access resources e.g fishery Pure public goods shares by all and owned by none e.g biodiversity Market Failure #1: Incomplete markets - refers to a situation where the institution has not established defined property rights e.g no clear ownership (such as resource of air) - Prices do not exist for resources in incomplete markets, although there is implicit prices referred to as shadow prices (which can be revealed through WTP in non-market valuation studies) - For many natural resources, markets are incomplete such as unpriced inputs to production Example is the incomplete market for clean air: - Absence of well-defined property rights - Use by one cannot be prevented by actions of another (non-rival/excludable) - No one absorbs cost for reducing air quality e.g air pollutors internalise no cost - Possible solution develop institutions which establish well-defined property rights à Coasian Solution

2 Market Failure #2: Externalities POSITIVE EXTERNALITY NEGATIVE EXTERNALITY ORIGIN OF EXTERNALITY CONSUMPTION Vaccination against infectious disease Noise pollution from the pub PRODUCTION Honey bees pollinating fruit trees Sulphurous emissions from a coal fired power station Negative Externalities Market for a pure private good: negative externality Pure private good assumptions: 1. Excludable can reasonably prevent others from accessing use of the good 2. Rival (exclusive) use by one will subtract benefit of another future user Social Marginal Cost Violation of the non-rival assumption involving negative impacts à could be thought of as a divergence between private costs and social costs à some external nuisance associated with a good will add costs to its use which can be thought of as adding a marginal nuisance cost to the private marginal cost of production to derive the SMC curve Social Marginal Cost (SMC) = Private Marginal Cost (PMC) + Marginal Nuisance Cost Market for a non-pure private good: negative externality Grey area represents costs associated with good consumption What is a nuisance and who experiences them? Nuisance à can be defined as any type of pollutant e.g emissions/ late night noise/ light pollution etc Pollutee à bystander in close proximity to the pollutant and are adversely impacted by the violation of the assumption of rival-ness in markets - Reduced amenities from pollution - Increase amenities from abatement

3 Total social welfare will be maximised where SMC intersects demand Socially Optimal Abatement intersection between SMC and demand Taxes and Negative Externalities How to maximise total social welfare in the presence of a negative externality à command and control : take action that limits (or induces action to limit) production to socially optimal quantity or assign ownership over the resource in conflict. Lecture 7: Quantity Rationing Coase Theorem Approaches the problem of social cost from a different perspective to Pigouvian - Requires government to provide appropriate price signals to externality producers - Coasian approach views pollution as a resource conflict so the role of government is to establish well defined property rights over the resource and facilitate the market interactions to exchange those rights of use. Coase Theorem Assumptions: 1. No transaction costs 2. Perfect knowledge no asymmetry problems or adverse selection (when information asymmetry leads to one side of a market self selecting in a way that exposes the other side of the market to inferior outcomes) 3. Competitive market no market power 4. Profit/ utility maximising agents 5. No wealth or income effects Coase suggests that under these assumptions, it doesn t matter who is allocated the rights: - e.g allocate to polluters à whereby pollutees would come and negotiate the purchase of some of those rights - allocate to pollutees à in which polluters would negotiate to purchase to MDC = MAC Coasian approach - Seen as a mechanism which overcomes the information burden of setting the right price in pigouvian mechanisms - market exchange for the resource will reveal information held by provide agents, but otherwise unknown to the government - market action will establish a price though exchange which has similar incentive effects as an emissions tax Process of quantity rationing 1. Government identifies the resource in conflict 2. Government defines property rights over the resource a. Ownership allows use of the resource within the bounds of the property rights i.e pollute or not pollute

4 3. Government allocates ownership shares of the resource to agents à perhaps by direct grant/ auction or lottery 4. Government sets the rules of market exchange and enforces ownership rights à law courts and defined legal liability for action outside of rights In actuality, there aren t that many pure Coasian solutions because the application sets government to act on behalf of pollutees (consumers). In practice, rarely will polluters (producers) negotiate with the government. Instead, we see negotiation happy between suppliers. The social optimum under Coasian application is the pollution cap where producers negotiate with each other to buy and sell rights within the pollution cap. In short, the issues in regards to uncertainties in determining the socially optimal level of pollution have not been resolved. Emissions tax information burden on identifying the socially optimum level of pollution mean the emissions tax could not provide certainty about ensuring the optimum level of pollution. Permit Trading Scheme - Dales (1968): tradable permits specify a pre-determined level of emissions within a specified region. - Permits that are distributed = the permissible total emissions (cap) are distributed to producers in the region - They can be traded freely amongst polluters - Those who pollute less than their allocated portion can sell excess permits for a profit, creating a mechanism for excess supply/demand absorption - Trade will occur in the market based on the heterogeneity in abatement costs àlow cost abaters can trade permits who have high cost abatements The model of tradeable permit scheme is a constrained cost minimisation problem. Information requirements for the scheme includes: - The current total emissions - The underlying total or marginal abatement costs of emitters covered in the scheme. Example: 2 emitters (PS and INC) à - Incinerator: 10 units - Power Station: 18 units - Small emitters generally have higher beta values which mean larger marginal abatement costs ß subject to emissions constraint

5 Cost minimising solution: MAC PS = MAC INC = λ (shadow price of emissions/ optimal cost of permits for the system/ optimal tax to achieve socially optimal level of abatement) λ is the value of the permits in the market and also the equivalent emissions charge to achieve the same outcome. An additional interpretation of λ is that it gives an approximation of the additional total cost we would incur if we increased the abatement target by one unit (equivalently, the decrease in total cost that would be expected if the abatement target was relaxed by 1 unit). Establishing a tradable permit scheme In designing the market to set up the scheme, the government will have consideration for the following requirements: 1. Time frame of the permits à what period of time can the emissions be produced e.g daily/ monthly/ annually 2. Monitoring and data collection regime 3. Available mechanisms to allocate permits at low transaction costs Several criteria for an efficient scheme: - Permits are well defined - Permits are storable and bankable - Freely tradeable in which producers can keep the profits - Transaction costs are minimised where possible - Penalty for non-compliance is greater than the cost of the permit - Permits are able to be expropriated exclusively by the government to maintain market stability Example: Emissions Trading Scheme - Response to the Kyoto Protocol - 12,000 emitters whom were allocated permits for and were required to settle accounts at the end of the period - 95% of permits were allocated at no cost to emitters - Problem with the scheme is that the initial allocation of permits to emitters exceeded the total volume of emissions during the period à consequently, price collapsed to almost zero Uncertainties and Quantity Rationing Effectiveness Weitzman demonstrated that in the presence of uncertainties regarding the marginal cost/ benefits of abating pollution, the effectiveness of quantity rationing mechanisms depend on: - Slopes of the pollution cost (MDC) curve and MAC curve - How far expectations deviate from reality In general, the greater the curves of the MAC or MDC curves the less the likely error in setting the emissions cap when we have some uncertainty about one or the other: - If MDC or MAC known and flat, then worst case - If MDC or MAC both steep, even if unknown, then the likely error in setting the emissions cap reduces This is the mirror case to the emissions charge, whereby the greater the slopes of the MAC/MDC, the greater the error is in setting the charge when there are uncertainties present. Thus, emissions caps appear to work best under the conditions where the emissions charge is least effective. Price vs Quantity Rationing Effectiveness The effectiveness of emissions charges and permit trading schemes can differ according to the level of willingness to accept some degree of error: 1. Is it more important to get the quantity of a pollutant correct? Under uncertainty, tradeable permits provide a known quantity cap, but cost is uncertain 2. Is it more important to have some certainty re price of emissions reductions? Under uncertainty, the emissions charge provides known upper-bound cost signal to producers, but quantity abated/emitted is uncertain. If the pollutant quantity is close to exceeding a highly damaging threshold à quantity controls are important - E.g pollutants like nutrient loading in water catchment areas

6 DYNAMIC MODEL à Market-Based (incentive) Mechanisms 1. First: Defined efficient level of pollution by solving a finite time constrained optimisation problem 2. Second: Once the efficient level is found, governments need to establish well-defined property rights (Exclusive/Rival/Transferrable/Excludable/ Enforceable) 3. Third: Governments to distribute ownership shares according to one of the following schemes: SCHEME DIAGRAM OPTIMISATION/MAXIMISATION IMPORTANT POINTS UNCERTAINTIES (Weitzman 1974) Effectiveness of emissions charge depends collecting the correct information: - Slopes of the MDC and MAC - How far expectations deviate from reality Price Rationing: Emission Charge (Tax) Pigou: state should execute pollution regulation in achieving social optimum through price incentives (taxes/subsidies). Tax: charged where MAC = MDC Cost Effective Allocation of Control Responsibility: point where MAC 1=MAC 2 - Equate this and obtain q 1 and q 2 by solving simultaneously subject to emissions constraint Profit Maximisation: pq c(q) tq à [(price x quantity)-(cost at q) (MDC)] à FOC s will produce optimal price Optimal Quantity (q*): given where marginal benefit (p) is equal to Social Marginal Cost (PMC + Tax) Double Dividend: use revenue from Pigouvian Tax to offset other distortionary taxes in the economy but tax interaction effect potentially diminishes benefit of lower taxes by exerting upward pressure on prices caused by higher taxes on polluters. Tax will be set according to expected MDC and MAC intersection. - Higher than expected MAC: Tax too low causing tax and emit strategy to be perferred since cheaper - Lower than expected MAC: Tax too high inducing too much abatement - Higher than expected MDC: Tax too low encouraging not enough abatement. The greater the gradient of the MAC/MDC curves, the greater risk of inefficiently setting the tax in the presence of uncertainties. INFORMATION REQUIREMENTS Charges can be efficient in the sense that administrators do not need to know the source of the pollutant and achieve a social optimum via self motivated behaviour of each firm whilst accommodating to individual MAC curves. Also gain advantages from double dividend Problem with setting price incentives is that governments require substantial information about the nature of damage and abatement costs. The impact of missing the target depends on the elasticity of the control cost curves. In this way, the efficiency of emissions charges can be compromised by asymmetric Information Problems à producers have incentive to disguise their actions from the regulator moral hazard