Answer 3-4 big questions about Environmental Econ within 1.5hours tomorrow
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PollutionPermits1.docPollution Permit Trading Systems
A pollution permit trading system can be implemented through the use of credits or allowances.
Under a pollution credit system, a polluter earns marketable credits only if it emits below an established standard.
With pollution allowances, each permit gives the bearer the right to release some amount 0f pollution.
Both are marketable, so that polluters can buy and sell credits and allowances as needed based on their access to abatement technologies and their cost conditions.
A system of marketable pollution permits has two components:
(1) the issuance of some fixed number of
permits in a region; and
(2) a provision for trading these permits among
polluting sources within that region.
Once the permits are distributed, a bargaining process develops, which gives rise to a market for “pollution rights”.
Polluters either
buy these “rights to pollute”
or
abate
whichever is the cheaper alternative.
High-cost abaters have an incentive to bid for available permits, while low-cost abaters have an incentive to abate and sell their permits on the open market. The result is a cost-effective allocation of abatement responsibilities.
The tradable permit system accommodates environmental objectives defined at an aggregate level.
The trading component of the permit system capitalizes on differences in polluters’ abatement technologies and opportunities.
Polluters that can abate efficiently are given the incentive to do so because they can sell their unused permits to their less-efficient counterparts. As long as the environmental goal is achieved in the aggregate, the benefit to society is the same whether every firm does an equal amount of abating or if the task is undertaken by a select few. However, the costs will be markedly lower if abatement is done by more efficient polluters.
Example:
Consider two polluters, 1 and 2:
Polluter 1: TAC1 = 1.25(A1)2
MAC1 = 2.5(A1)
Polluter 2: TAC2 = 0.3125 (A2)2
MAC2 = 0.625 (A2)
Each polluter is currently releasing 10 units of pollution for a total of 20 units in the region.
The government sets an “acceptable” level of pollution at 10 units and issues 10 permits each of which allows the bearer to emit one unit of pollution.
Assume the government allocates 5 permits to each polluter.
ROUND 1: Government issues five permits to each polluter
Polluter 1: Current pollution level: 10 units
Number of permits held: 5 Abatement required: 5 units
MAC1 = 2.5 (A1) = 2.5 (5) = $12.50
TAC1 = 1.25 (A1)2 = 1.25(5)2 = $31.25
Polluter 2: Current pollution level: 10 units Number of permits held: 5 Abatement required: 5 units
MAC2 = 0.625 (A2) = 0.625 (5) = $3.125
TAC2 = 0.3125 (A2)2 = 0.3125 (5)2 = $7.81
If no trading of pollution permits is allowed, each firm must abate 5 units and the combined abatement cost is $39.06.
If trading is allowed, Polluter 1 (the higher-cost polluter) has an incentive to buy permits from Polluter 2 so long as the purchase price is less than its MAC. Polluter 2 has an incentive to sell permits so long as it gets a price greater than its MAC.
Assume the two polluters agree on the purchase and sale of one permit at a price of $8.00.
Polluter 1 now has the right to pollute 6 units and must abate 4 units.
Polluter 2 has the right to release 4 units of pollution and must abate 6 units.
ROUND 2: Polluter 1 purchases one permit from Polluter 2
Polluter 1: Current pollution level: 10 units
Number of permits held: 6 Abatement required: 4 units
MAC1 = 2.5 (A1) = 2.5 (4) = $10.00
TAC1 = 1.25(A1)2 = 1.25(4)2 = $20.00
Cost of one permit purchased = $ 8.00
Polluter 2: Current pollution level: 10 units Number of permits held: 4 Abatement required: 6 units
MAC2 = 0.625 A2 = 0.625 (6) = $ 3.75
TAC2 = 0.3125(A2 )2 = 0. 3125(6)2 = $11.25
Revenue from one permit sold = $ 8.00
The total costs of abating 10 units of pollution are now $31.25 ($7.81 less than the costs without trading).
Polluter 1 is better off by $3.25:
Abating costs + price of permit = $28 (was $31.25 in round 1)
Polluter 2 is also better; its net expenditures associated with abating and trading are $3.25 (TAC2 of $11.25 less revenue from sale of one permit at $8).
In round 1, TAC2 was $7.81. Hence it costs $4.56 ($7.81 - $3.25) less for polluter 2 at the end of round 2.
So long as the two polluters face different MACs there is an incentive to buy and sell permits. Buying and selling of permits stop when MAC1 = MAC2.
FINAL ROUND: Polluter 1 Purchases a Total of Three Permits from Polluter 2:
Equalization of MAC across Polluters is achieved
Polluter 1: Current pollution level: 10 units Number of permits held: 8 Abatement required: 2 units
MAC1 = 2.5 (A1) = 2.5 (2) = $5.00
TAC1 = 1.25(A1)2 = 1.25(2)2 = $5.00
Cost of three permits purchased = $20.00
Polluter 2: Current pollution level: 10 units Number of permits held: 2 Abatement required: 8 units
MAC2 = 0.625 (A2) = 0.625 (8) = $5.00
TAC2 = 0.3125 (A2)2 = 0.3125(8)2 = $20.00
Revenue from three permits sold = $20.00
The results are the same as when a $5 pollution charge is imposed because both instruments operate through the polluter’s MAC. However,
1. With a pollution charge, the government has to search for the price that will bring about the requisite amount of abatement. In the permit system, trading establishes the price of a “right to pollute” without outside intervention.
2. The pollution charge generates tax revenues on all units of pollution not abated, while there are none from the permit system. However, a trading system can be designed to generate revenues, if the government sells or auctions off the initial allocation of permits.
3. The trading system is more flexible in that the number of permits can be adjusted to change the environmental objective.
If the objective is too stringent, mote permits can be introduced.
If it is too lenient, the government, environmental groups, or concerned citizens can buy up permits, effectively reducing the amount of pollution allowed in the affected region.
