Abstract
This paper compares a firm’s short run optimal production and abatement rules under emission level standards and standards expressed in terms of emissions per unit of output (ratio standards). The models allow for non-compliance with standards, with expected penalties dependant on either level or relative violations of the standard in question. It is shown that ratio arguments make a difference to the optimal decision rules derived for a profit-maximising firm. For example, for a given level of emissions the firm both produces more, and abates more, under a ratio standard, so that ratio and level standards cannot be used interchangeably to achieve the same combination of emissions and output. The implications for the efficiency of pollution control are briefly discussed.
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Notes
A firm’s expectations are key here. Expected penalties may be a function of relative violations even if the regulator’s design of the penalty structure is based upon nominal violations.
Note that, as a result, in an industry of heterogeneous firms, each firm’s marginal costs of reducing its pollution to output ratio are not equalised.
It is assumed that additional inputs are required for pollution abatement, i.e., inputs which would not otherwise be employed in the production process. The firm’s short run costs, therefore, are assumed to be separable in production of the good/pollutant and in pollution abatement. Note that the abatement cost function here differs from that of Harford (1984) and McKitrick (2001) who model abatement costs as a direct function of the firm’s pollution to output ratio.
The components of the expected penalty P(·) are the (subjective) probability of detection ϕ(·) (dependant upon the size of the violation as well as the enforcement parameters of the regulatory regime) and a monetary fine F(·) incurred if detected, so that P(·)≡ ϕ (·) F(·).
This is readily affirmed by replacing the expected penalty term in the Lagrangian function with a constraint term and then solving the first-order conditions for the appropriate Lagrange multiplier.
The alternative explanation, that we have B′(q*) and C′(a*) for the non-compliant firm both proportionately greater, can be ruled out immediately, since this would imply that the non-compliant firm is producing less, and abating more, than a compliant firm, which is nonsense.
Note that the same result is obtained if expected penalties depend upon the violation “level” expressed in ratio units, i.e., e/q – R
This is true as long as the nominal cost of a percentage reduction in emissions per unit of output is increasing in output, which will generally be the case
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Acknowledgements
I would like to thank two anonymous reviewers whose challenging comments and helpful suggestions aided considerably the preparation of the final version of the paper.
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Hatcher, A. Firm behaviour under pollution ratio standards with non-compliance. Environ Resource Econ 38, 89–98 (2007). https://doi.org/10.1007/s10640-006-9063-6
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DOI: https://doi.org/10.1007/s10640-006-9063-6