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

Environmental Subsidies

(1) Abatement Equipment Subsidy

Abatement equipment subsidies are aimed at reducing the costs of abatement technology.

Subsidies are “negative taxes,” they have a similar incentive mechanism to pollution charges except that they reward for not polluting as opposed to penalizing for engaging in polluting activities.

They can be implemented through

· grants,

· low-interest loans, or

· investment tax credits, etc.,

all of which give polluters an incentive to invest in abatement technology.

To achieve an efficient equilibrium, the subsidy must equal the marginal external benefit (MEB) measured at the efficient output level.

Say the market for scrubbers is given by:

MSC = 70.0 + 0.5Q, MEC = 0

MPB = 350.0 – 0.9Q

+MEB = 56.0 – 0.2Q

MSB = 406.0 – 1.1Q

The corresponding graph is given below. The competitive equilibrium is found where

MPB = MSC, or at Qc = 200 and Pc = $170 million.

However, the efficient equilibrium occurs where MSB = MSC, or at Qe = 210, and Pe = $175 million. In an unregulated competitive market, too few scrubbers are exchanged at too low a price because the external benefits of a cleaner environment are not recognized by the market participants.

If a subsidy (s) were provided to demanders (i.e., polluters), equal to the MEB at the efficient output level, more scrubbers would be traded.

In this case, the Pigouvian subsidy would equal

MEB = 56.0 - 0.2(210) = $14 million,

shown as distance KL in the diagram.

The effective price to polluters would be the efficient market price less the subsidy, or (Pe - s), which in this case is ($175 — $14) or $161 million.

One problem with implementing a subsidy is measuring the MEB: Monetizing the marginal external benefits of such intangibles as better health and more stable ecosystems is difficult at best. Hence it is not likely that a subsidy of abatement equipment will achieve allocative efficiency.

However, its associated effect of encouraging greater consumption because of an effectively lower price should still occur.

This type of control instrument biases polluters’ decisions about how best to abate. Subsidies affect relative prices, making other alternatives less attractive to polluters from a financial perspective. However, some of these abatement alternatives might be more effective in reducing pollution.

Innovation of a potentially superior abatement system could be discouraged as long as the government is subsidizing existing equipment.

Finally, subsidies must be financed through taxes or government borrowing. Thus, they effectively redistribute income from society to polluters.

(2) Per Unit Subsidy on Pollution Reduction

In this case, the government agrees to pay the polluter a subsidy (s) for every unit of pollution removed below some predetermined level, Z0.

This is modeled as:

Per unit subsidy s = s(Z0 – Zi),

Where Zi is the actual level of pollution.

A per unit pollution reduction subsidy might be less disruptive than an equipment subsidy; it definitely avoids any technological bias.

These subsidies, however, can have the perverse effect of elevating pollution levels in the aggregate: A per unit subsidv effectively lowers a polluter’s unit costs, which in turn raises its profits.

If the industry has limited entry barriers, these profits would attract entry into the industry.

In the long run, although each individual polluter reduces its emissions, the subsidy may cause the market to expand such that aggregate emissions end up higher than they were originally.