Abstract
The preceding section closed by stating a serious problem: market failure. It is at this point that a third «protagonist» is called upon the «stage» of economics to make amends, the government. To see how this might be done in principle, we introduce the concept of «internalizing externalities», an idea that the media love to quote but seem to not always fully understand. Then, we turn from the principle to its practical application. Pollution taxes and command and control are introduced as alternative environmental policy instruments, and are evaluated according to economic criteria. This chapter is supposed to show how microeconomic analysis, as discussed in the preceding chapter, is useful for the analysis of environmental problems and policy. In the main part of this chapter, we will follow the standard economic textbook procedure assuming production and abatement technology to be given. However, the chapter is completed by a discussion of environmentally friendly technical change.
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Notes
- 1.
We are talking about the firm as it is stylized in mainstream microeconomic models. It is not so easy in reality. Here, the manager of a firm might care for the environment because his/her conscience does not allow doing otherwise, or because doing otherwise would draw punishment from the consumers, or employees (or even his/her children at home at the breakfast table!). In this introductory textbook we ignore these real deviations from the standard model of the firm. We may do so without worrying too much about this omission because the standard model of the firm catches an important part of reality. If it were otherwise we would not suffer as much from environmental problems as we do.
- 2.
The Pigouvian tax is the Godfather of all kinds of ecological taxes that are presently used in most industrial countries. See Dias Soares et al. (2010) for a recent overview. The authors emphasize that the numerous examples of environmental taxes from the many different countries discussed in their analysis are all part of the «Pigouvian approach» (p. 23).
- 3.
In 7 Sect. 6.5.3, it has been noted that the terms «marginal external cost» (MEC) and «marginal environmental damage» (MED) are synonyms. To recall that, the respective curve in . Fig. 7.1 is labelled MED (= MEC).
- 4.
It may be noted that the tax rate drives a wedge between the price consumers pay (p ∗∗) and the price producers receive (p ∗∗ − τ ∗∗). Market price increases due to the imposition of the tax, although the price increase (p ∗∗ − p ∗) is smaller than the tax rate (τ ∗∗). So the burden of the tax is shared among producers and consumers in that consumers pay a higher price and producers receive a lower price compared to the situation without tax.
- 5.
See, e.g., Endres (2011, pp. 174–187), for a critical appraisal.
- 6.
An equivalent way to put this is to say that marginal abatement costs decrease with emissions.
- 7.
Calculus club, mini session: TC(e) = AC(e) + ED(e), where TC is total cost and AC and ED are abatement cost and environmental damage, respectively. e is the level of abatement. Given the functions are well-behaved, we find the cost minimum level of e by ∂TC/∂e = ∂AC/∂e + ∂ED/∂E ⋅ ∂E/∂e = 0. ∂E/∂e = − 1,since emissions go down by 1 unit if emission abatement is increased by 1 unit. Therefore, the condition for the cost minimum given above can be rewritten to ∂AC/∂e = ∂ED/∂E. The term on the left-hand side stands for marginal abatement cost, the one on the right-hand side for marginal damage. This is exactly the condition phrased verbally in the text above.
- 8.
- 9.
Calculus club, mini session: the marginal abatement cost function is the first order derivative of the total abatement cost function.
- 10.
In formal terms, i ∈ {1, 2} holds.
- 11.
For simplicity, we interpret «not to be exceeded» such that the two individual emission quantities add up to exactly\( \overline{E}. \)
- 12.
«ab initio» is a mildly snobbish expression for «right from the start».
- 13.
With the term «general», we mean that a tax rate is not differentiated across firms.
- 14.
A prerequisite for the evolution of a market is that emission rights are scarce. If the firms are «flooded» with costless pollution allowances, no one wants to buy and the equilibrium permit price is zero.
- 15.
- 16.
The curves in this figure are the same as in . Fig. 7.5 illustrating the pollution tax in the standard and pricing approach. This is to facilitate the comparison between these two standard-oriented environmental policy instruments.
- 17.
Technical progress may also materialize in the form of new or improved products, see 7 Sect. 9.2.6.3.
- 18.
From the potential user’s point of view, the analogon to diffusion is adaptation, i.e. introducing the new process with the user in question.
- 19.
See Crisp (2016).
- 20.
See Baker and Adu-Bonnah (2008) for applications of different stylizations of environmental technical progress and for their consequences for the model results.
- 21.
In the context of macroeconomic modeling of technological progress that will be delineated later in 7 Sects. 9.2.6 and 10.1.3, such a reduction of the emission coefficient might be classified as ‘resource-augmenting’ technical change. This means that, ceteris paribus, a given output can be produced with less input of a natural production factor. For example, if engineers succeed to develop a car that emits less pollutants E per driven kilometre x, the emission coefficient E/x declines. In macroeconomic terminology, the input of clean air to production declines, since emissions imply a reduction of the amount of clean air available. In other words, the productivity of a given amount of clean air rises, which is equivalent to an improvement in technical efficiency.
- 22.
This is cost efficiency as introduced above. How improvements in terms of cost efficiency may lead to improvements in allocative efficiency will be dealt with in the 7 Sect. 7.3.2.2.
- 23.
See Clark et al. (2008) for a comparison of these patterns and their use in practice.
- 24.
Investment in R&D is also dealt with in the macroeconomic part of this analysis (see 7 Sects. 9.2.6.3, and 10.1.1.3).
- 25.
Moreover, cost efficiency requires more information compared to technical efficiency. To be brief, we ignore technical efficiency below.
- 26.
As useful as this simplification may be, it has its price, too: problems of optimal environmental policy timing tend to be overlooked when the model is reduced to two periods.
- 27.
- 28.
The following Calculus Club session is also an extension (and sophistication) of the Calculus Club mini session of footnote 7.
- 29.
For simplicity, environmental damage ED is written to depend on emission abatement (e) instead of emissions (E). Since initial emissions E ∗are given and assumed not to depend on technical progress \( \left({E}^{\ast }={E}_0^{\ast }={E}_1^{\ast}\right), \) the two aforementioned stylizations are equivalent to each other. Moreover, it is worth noting that ED does not carry a subscript t. This means that we assume the damage function to be time-invariant. ED t might be suggestive in a model of technical change, different from the one used above. If technical change would be stylized to increase the capacity of the environment to cope with pollution, then the introduction of new technologies would make the damage function shift downward. In this case \( E{D}_1\ \left(\overline{e}\right)<E{D}_0\ \left(\overline{e}\right)\forall \overline{e}\in \left(0,\kern0.5em {e}^{\ast}\right). \)
- 30.
To make sure that the second-order conditions for the cost minimum are met, we also assume\( \frac{\partial^2 SC}{\partial {e}_1^2}\cdot \frac{\partial^2 SC}{\partial {I}_0^2}>{\left(\frac{\partial^2 SC}{\partial {e}_1\partial {I}_0}\right)}^2 \) from which follows that SC is strictly convex.
- 31.
Standard-oriented environmental instruments were explained in 7 Sect. 7.2 in the static setting.
- 32.
See, e.g., Endres and Rundshagen (2010).
- 33.
Now we are entering the rough terrain of the «Theory of Second Best». See Lipsey (2007) for a general survey.
- 34.
See e.g. Hall (2016).
- 35.
The «patent law» is meant to limit the negative incentive effects arising from research spillovers. A more detailed analysis shows, however, that this (as with so many things in life!) is not as simple as it seems at first sight. See e.g. Parry (2003).
- 36.
Industrial economics is concerned with the analysis of the behaviour of firms and the functioning of markets. This includes organization of industry, pure and applied oligopoly theory, product diffentiation, theory of the firm and internal organization, regulation, monopoly, merger as well as technical change and technology policy. (This elaboration is inspired by the aims and scope section of The Journal of Industrial Economics.)
- 37.
This is also an issue in New Growth Theory (see the discussion of the Romer Model in 7 Sect. 9.2.6.3).
- 38.
This is a special case of the Tinbergen Rule of economic policy saying that the number of policy instruments applied must equal the number of allocation problems these instruments are supposed to solve. A critical assessment with particular emphasis on energy and environmental policy is in del Rio and Howlett (2013).
- 39.
An example for this kind of an analysis is Endres et al. (2007).
- 40.
Under strict liability, the polluter is liable no matter what the level of emissions is. Under negligence, the polluter is exempt if actual emissions equal (or fall short of) a certain maximum standard of emissions. In most economic models it is assumed that the social planner (the regulatory agency) chooses the socially optimal level of emissions to be the norm of maximal emissions.
- 41.
See e.g. Judd et al. (2012).
- 42.
Market power might arise as a result of non-rivalry of knowledge in connection with patent law. This is dealt with in the context of the discussion of the Romer Model in 7 Sect. 9.2.6.3.
- 43.
See e.g. Lafay and Maximin (2015).
- 44.
See, e.g., Kollmann and Schneider (2010).
- 45.
The problem referred to above is called a «prisoners’ dilemma» in microeconomics. See, e.g., Varian (2014, pp. 545–547). A critical assessment of the prisoners’ dilemma’s application to global environmental problems is in Endres (2011, pp. 228–235, 247–249).
- 46.
See, e.g., Endres (2011), Finus and Rundshagen (2015, 2016).
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Endres, A., Radke, V. (2018). A Sketch of Environmental Microeconomics. In: Economics for Environmental Studies. Springer Texts in Business and Economics. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-662-54828-8_7
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