Week 5- Government Intervention to Correct Market Failure Flashcards Preview

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Flashcards in Week 5- Government Intervention to Correct Market Failure Deck (38):

draw: socially efficient level of environmental quality (MAC+MDF)

- Marginal abatement cost curve (downward sloping). continues to zero and high pollution because there is so many damages that the site is better left degraded
- Marginal damages curve (upward sloping). e.g sediment pollution in river from logging makes it unsafe to swim in and biodiversity decreases.


Draw: Social costs when pollution is greater than optimal

- deadweight loss on right hand side of graph
-costs society more in form of environmental degradation than benefits of greater pollution (production).


Draw: Social costs when pollution is lower than optimal

- costs society more to clean up then the benefits of lower pollution.
- deadweight loss on left


Draw: optimal level of pollution with technological innovation

- MAC (abatement cost) curve lowered.
- new level of optimal pollution as it costs less for society to clean up or less damages from production


Pigouvian approach to market failure

- use taxes to remove divergence between MSC and MPC, and MSB and MPB


Pigouvian tax on timber production (negative externality)

-increase MPC of production to where MSC intersects MSB curve with tax
- tax to remove deadweight loss from over harvesting


Pigouvian approach on positive externalities



Problem with pigouvian approach of levying taxes on production of timber when externality is water quality

doesn't encourage development of technology that minimises impacts on water quality


solution to pigouvian tax problem

- externality should be taxed (e.g sediment levels in water, not volume of timber harvested


public good eg

air, national defence, knowledge


why market failure for public goods

private market will not supply the good since no one would pay for it because they cannot be excluded from benefits ("free rider")


externalities associated with public goods are...



the social value of public goods are substantially greater than the private value because

because benefits are non-rivalrous and non-excludable


free market quntity of public good is ___ than sociall efficient quantity

less... because private producers cannot avoid free riders.


socially efficient price



Coase's approach to correction of market externalities

- gov intervention not neccesary
- clearly defined property rights is all that is necessary
- market for externality will automatically develop
-bargaining between generator and victims of externality will lead to socially efficient level of an externality.
- Whoever has the property right will receive payments. The party without the property rights will pay a bribe to the party with the property rights


Coase: initial distribution of property rights ____ ___ affect reaching the efficient level of the externality



Coase: The initial distribution of property rights ___ affect costs and benefits for polluters and people affected by the externality



Conditions for Coases theorm to hold:

(1) absence of transaction costs;
(2) well defined property rights;
(3) perfect competition in the abatement market;
(4) no income effects;
(5) no effects on entry or exit of firms; and
(6) no free riders.


endowment effect

people more willing to pay for an improvment in envm quality than they are to recieve compensation for a reduction as they are happy where they are


Public policy and instituional appraoches to correct market failure

-Moral suasion (convince public + > -)
- direct public production (bioversity conservation)
- Command and control
- Property rights and creating markets
- Economic incentives (tax and subsidies + Marketable pollution permits)


Command and control

-government restrictions on inputs and outputs
- e.g never exceed a level for some air pollutant
- not always a set-quanity e.g technology standards - seat belts in cars


does command and control provide abatement incentives (beyond standards)?



For command and control policies to allocate pollution abatement efficiently between firms:

-frims must have identical MAC or
- gov know MAC of each polluter



MPPs minimise total abatement costs and provide incentives while achieving target level of pollution with a high degree of certainty


MPP conditions

-after initial allocation of permits, polluters are free to trade
- polluters with high MAC will have incentive to buy pollution permits
- polluter with low MAC will have incentives to sell pollution permits

Therefore. MACs will equate


Coase assumption 1: absence of transaction rights

-increasing lines (difficulty) of communication with increasing participants
- could go through courts


Coase assumption 2: well-defined property rights

- if rights are not specified by legislation, regulation or custom, making bargaining difficult
- litigation to solve


If MDF is underestimated when setting a tax...

- The MAC should be up to left
- crosses MAC at higher cost level
- efficient tax level is higher
- efficient level of pollusion is lower


Why pigouvian tax's and tradeable pollution permit will result in more efficient pollution reduction than CandC

- CandC typically require firms to reduce pollution by the same amount. Given costs of abating pollution varies between firms, compliance costs will be low for some and prohibitive for others


For CandC to incentivise for firms with low abatement costs to reduce more and not target firms with high abatement costs for large levels of emissions reduction

-GOV would need to know MAC of each firm.


draw CandC: 3 diagrams, 2 firms with high and low emission abatement
50% reduction

-firm 1 emits 10 units unregulated (less steep curve)
-firm 2 emits 6 unregulated (steep curve)
- both required 50% reduction so firm 1 pays less than firm 2


1 situation where CandC can be more efficient than tax

- Agggregate MAC not known for society, and so if tax is set too high (e.i industry will collapse) or low (poor health outcomes) socially inefficient outcomes will result.
- CandC can achieve target with more certainty, than waiting to see the outcome of a tax if situation is dire.


Pigouvian tax incentives

- For firms have less units of pollution to pay tax on if they undertake greater emissions reductions


MPP tax incentives

- firms can buy less PP if they voluntarily abate pollution.


Pigou+MPP meeting efficient target

- frims with low abatement have finacial incentives to reduce emission more than high abatement cost firms
- firms with high abatement costs are better off paying per unit of emission tax or buying PP.


CandC does not promote pollution reduction technology because...

firms have no incentive to cut emissions below the regulated target- reducing emissions further will not reduce costs to the firm.


economic incentives does promote pollution reduction technology because...

tax and MPP will invest in new abatement tech that is less than per unit of emission tax.