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CU-Boulder ECON 2010 - The Economics of Pollution

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>>ExternalitiesSection 1: The Economics of Pollutionchapter19Pollution is a bad thing. Yet most pollution is a side effect of activities that provide uswith good things: our air is polluted by power plants generating the electricity thatlights our cities, and our rivers are damaged by fertilizer runoff from farms that growour food. Why don’t we accept a certain amount of pollution as the cost of a good life?Actually, we do. Even highly committed environmentalists don’t think that we canor should completely eliminate pollution—even an environmentally conscious socie-ty would accept some pollution as the cost of producing useful goods and services.What environmentalists argue is that unless there is a strong and effective environ-mental policy, our society will generate too much pollution—too much of a bad thing.And the great majority of economists agree.To see why, we need a framework that lets us think about how much pollution asociety should have. We’ll then be able to see why a market economy, left to itself, willproduce more pollution than it should. We’ll start by adopting the simplest frameworkto study the problem—assuming that the amount of pollution emitted by a polluter isdirectly observable and controllable.Costs and Benefits of PollutionHow much pollution should society allow? We learned in Chapter 7 that “how much”decisions always involve comparing the marginal benefit from an additional unit ofsomething with the marginal cost of that additional unit. The same is true of pollution.The marginal social cost of pollution is the additional cost imposed on societyas a whole by an additional unit of pollution. For example, acid rain damages fish-eries, crops, and forests, and each additional ton of sulfur dioxide released into theatmosphere increases the damage.The marginal social benefit of pollution—the additional gain to society from anadditional unit of pollution—may seem like a confusing concept. What’s good aboutpollution? However, avoiding pollution requires using scarce resources that could havebeen used to produce other goods and services. For example, to reduce the quantity ofsulfur dioxide they emit, power companies must either buyexpensive low-sulfur coal or install special scrubbers to removesulfur from their emissions. The more sulfur dioxide they areallowed to emit, the lower these extra costs. Suppose that we cancalculate how much money the power industry would save if itwere allowed to emit an additional ton of sulfur dioxide. That sav-ing is the marginal benefit to society of emitting an extra ton ofsulfur dioxide.Using hypothetical numbers, Figure 19-1 shows how we candetermine the socially optimal quantity of pollution—thequantity of pollution society would choose if all its costs andbenefits were fully accounted for. The upward-sloping marginalsocial cost curve, MSC, shows how the marginal cost to societyof an additional ton of pollution emissions varies with the quan-tity of emissions. (An upward slope is likely because nature canoften safely handle low levels of pollution but is increasingly2 CHAPTER 19 SECTION 1: THE ECONOMICS OF POLLUTIONPITFALLSso how do you measure the marginal social cost of pollution?It might be confusing to think of marginal social cost—after all, we have up to this point always defined margin-al cost as being incurred by an individual or a firm, notsociety as a whole. But it is easily understandable oncewe link it to the familiar concept of willingness to pay:the marginal social cost of a unit of pollution is equal tothe highest willingness to pay among all members of socie-ty to avoid that unit of pollution. But calculating the truecost to society of pollution—marginal or average—is adifficult matter, requiring a great deal of scientific knowl-edge. As a result, society often underestimates the truemarginal social cost of pollution.The marginal social cost of pollutionis the additional cost imposed onsociety as a whole by an additionalunit of pollution.The marginal social benefit of pollu-tion is the additional gain to societyas a whole from an additional unit ofpollution.The socially optimal quantity of pol-lution is the quantity of pollution thatsociety would choose if all the costsand benefits of pollution were fullyaccounted for.harmed as pollution reaches high levels.) The marginal social benefit curve, MSB, isdownward sloping because it is progressively harder, and therefore more expensive, toachieve a further reduction in pollution as the total amount of pollution falls—increas-ingly more expensive technology must be used. As a result, as pollution falls, the cost3 CHAPTER 19 SECTION 1: THE ECONOMICS OF POLLUTIONFigure 19-1Marginal socialcost, marginalsocial benefitQuantity ofpollutionemissions (tons)QOPT0$200Marginal socialcost, MSC,of pollutionMarginal socialbenefit, MSB,of pollutionOSocially optimalquantity ofpollutionSocially optimalpointThe Socially Optimal Quantity of PollutionPollution yields both costs and benefits. Herethe curve MSC shows how the marginal cost tosociety as a whole from emitting one more tonof pollution emissions depends on the quantityof emissions. The curve MSB shows how themarginal benefit to society as a whole of emit-ting an additional ton of pollution emissionsdepends on the quantity of pollution emissions.The socially optimal quantity of pollution isQOPT; at that quantity, the marginal social bene-fit of pollution is equal to the marginal socialcost, corresponding to $200.savings to a polluter of being allowed to emit one more ton rises.The socially optimal quantity of pollution in this example isn’t zero. It’s QOPT, thequantity corresponding to point O, where MSB crosses MSC. At QOPT, the marginalsocial benefit from an additional ton of emissions and its marginal social cost areequalized at $200.But will a market economy, left to itself, arrive at the socially optimal quantity ofpollution? No, it won’t.Pollution: An External CostPollution yields both benefits and costs to society. But in a market economy withoutgovernment intervention, those who benefit from pollution—like the owners of powercompanies—decide how much pollution occurs. They have no incentive to take intoaccount the costs of pollution that they impose on others.To see why, remember the nature of the benefits and costs from pollution. For pol-luters, the benefits take the form of monetary savings: by emitting an extra ton of sul-fur dioxide, any given polluter saves the cost of


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