Answer 3-4 big questions about Environmental Econ within 1.5hours tomorrow

Deposit/Refund Systems

The deposit/refund system attaches a front-end charge - the deposit - for the potential occurrence of a damag​ing activity, and guarantees a return of that charge (the refund) upon as​surance that the activity has not been undertaken.

It combines the incentive characteristic of a pollution charge with a built-in mechanism for controlling monitoring costs.

Waste can be disposed properly or improperly .

Improper or illegal waste disposal gives rise to a negative externality.

Deposit/refund systems are meant to force the potential polluter to account for both

the marginal private cost (MPC) and

the mar​ginal external cost (MEC)

of improper waste disposal, should that activity be undertaken.

The deposit component of the system is in​tended to capture the MEC of improper waste disposal. It forces the pol​luter to internalize the cost of any damage it may cause by making it absorb this cost in advance.

The refund introduces an incentive to dispose of wastes properly and prevent environmental damage from taking place at all.

Taken together, the system targets the potential polluter instead of penalizing the actual polluter, using the refund to reward appropriate behavior.

The Marginal Private Cost of Improper Waste Disposal (MPCIW) includes expenses for collecting and illegally dumping wastes plus the costs of improperly disposing recyclable wastes, such as the expense of trash receptacles, collection fees paid to a refuse company, and the opportunity costs of forgone revenue associated with recycling.

The Marginal Social Cost of Improper Waste Disposal (MSCIW) includes the MPCIW plus the MECIW represented implicitly as the vertical distance between MSCIW and MPCIW.

The Marginal Private Benefit of Improper Waste Disposal (MPBIW) is the demand for improper waste disposal.

It is motivated by the avoidance of time and resources to collect wastes, bring nonrecyclables to a landfill, and take recyclables to a collection center.

Since we assume no external benefits in this case, MPBIW = MSBIW.

In the absence of environmental controls, equilibrium is determined by the intersection of MPBIW and MPCIW, or QIW.

The efficient equilibrium occurs where MSCIW equals MSBIW, or at Qe, which is smaller than QIW.

In the diagram above, the percentage of improper waste disposal is measured from left to right on the horizontal axis and the percentage of proper waste disposal is measured from right to left. To correct the negative externality associated with improper waste disposal, a deposit/refund system is instituted with the deposit equal to the MECIW measured at Qe. The deposit equal to the vertical distance ab shifts the MPCIW up to MSCIW forcing market participants to establish a new equilibrium at the socially optimal level, Qe. The result is an increase in the proportion of wastes properly disposed of from QIW to Qe.

When a negative externality is present, too much improper waste disposal is produced; market participants do not consider the full impact of their actions.

The refund helps to deter improper waste disposal. The potential polluter has an explicit incentive to dispose of wastes properly, since doing so allows it to reclaim the deposit. Should dis​posers choose instead to discard their wastes illegally, at least they will have paid for the external costs in advance.

Authorities also have the flexibility to adjust the deposit or refund amounts to enhance the built-in incentives.

The refund encourages environmentally responsible behavior without adding significantly to government’s monitoring and compliance costs. What makes this instrument unique is that once established, the incentives operate with limited supervision.