Environmental Market Failure
Negative Externalities Costs imposed on a 3rd party not involved with the consumption or production of the good (the external cost) Divergence between private and social cost MSC=MPC+MEC The MEC = the negative externality The free market price is less than the optimum price leading to over consumption Welfare loss
Q: The market generated quantity (where privates crosses private) Q1: The optimum quantity (where social crosses social) Over consumption of Q-Q1
Unequal Distribution Effects
Citizens in poor countries are more likely to be affected by the consequences of global warming that those in rich countries
E.g. drought/flooding
They are also a lot less likely to have consumed the goods and services which caused the global warming
And a loss less able to protect them selves e.g. through insurance policies
There are inequities between those who contribute to global warming and those who suffer from it
Citizens of developed (polluting) countries pay less for their goods and services than the social costs of their production
MSC=MPC+MEC
Government Intervention to correct Environmental Market Failure 2 main types: Market based measures Designed to modify the price mechanism using strategies such as taxes and subsidies Government regulation Sometimes referred to as “Command and Control”, designed to create incentives for firms to reduce harmful emissions, such as pollution permits which allow pollution to a certain level
Environmental Taxation A tax placed on the producer of a good or service which is deemed to have a negative impact on the environment Designed to “internalise” the negative externality by increasing the private cost of production Tax aims to increase the private cost until it equals the social cost – to reach optimum P and Q (see dia on next slide) Tax revenues can be used to fund spending on “clean ups” and invested in new technology that are designed to have a lower environmental impact, e.g. “clean” energy sources Examples of environmental taxes: fuel duty, air passenger duty, landfill tax, London congestion charge
Problems with Environmental Taxation
Vary difficult to place accurate monetary values on the environment and externalities e.g. loss of habitat, so very difficult to decide on tax levels
Price elasticities of demand and supply are often not known and vary over time, meaning that it is very difficult to know how much to increase tax by to achieve a certain reduction in pollution
If the demand for a product with adverse environmental effects is inelastic, the tax may raise revenue which can be put to good use but will only reduce consumption slightly
Imposing taxes on some environmentally harmful goods such as cigarettes may be seen as regressive and worsen the distribution of income and wealth
Increasing environmental tax in one country may reduce the countries international competitiveness and encourage firms to move to countries with lower environmental taxes, which may perversely act to increase global pollution as firms take advantage of low pollution taxes in rapidly developing countries such as China and India
Pollution Regulation Instead of using taxation the government could regulate The government could set a quota they believe corresponds with the optimum level or ban certain pollution generating activities In the UK the Environmental Protection Act of 1989 set minimum environmental standards for industries such as waste incineration and oil refining Regulatory Bodies e.g. Her Majesty's Inspectorate of Pollution inspect and fine firms that do not conform to the emission standards that have been set However, monitoring regulations can be difficult and expensive In addition, regulation does not generate tax revenues that could be used to support environmental improvement schemes or compensate those who have been adversely affected by pollution
Extending Property Rights Tragedy of the Commons The over exploitation of natural resources that are not owned by single individuals or organisations Because no-one owns the air or sea no-one takes responsibility for them and they are over exploited This is called the tragedy of the commons Instead of using taxation or regulation the government could create a market in property rights – the This internalises the negative externality through making the polluters pay and helps to limit the negative impact on the environment Examples: tradable pollution permits, emissions trading, carbon trading Popular in developed countries
Pollution Permits
What is it? These is a permit sold to firms by the government allowing them to pollute up to a certain limit. These can be bought and sold between firms. Exceeding your legal limit will result in huge fines. Advantages
The government can cap the total emissions allowed within a time period by limiting permissions sold
The firm’s which cause the most emissions pay the most
Gives firms an incentive to reduce emissions
Generate revenue which can be used to further R&D into sustainable energy – intergenerational equity (fairness)
Uses market forces to limit emissions rather than regulation
Disadvantages
The system must be enforced to be effective
Requires teams of factory inspectors
Careful thought is required regarding the fines imposed if limits are exceeded
Extending Property Rights to overcome the Tragedy of the Commons Activity page 113 Tradable carbon pollution permits Giving internet service providers the right to claim damages from distributors of spam for the extra cost incurred from the damage from spammers operations
Tradable quotas for water pollution Granting property rights to local citizens who can then claim damages from offenders Tradable quotas for fishing
Grant licenses for short term logging / logging quotas
Environmental Market Failure Intervention Options Summary Taxation Fuel duty, air passenger duty, landfill tax, London congestion charge Regulation Environmental Protection Act of 1989 - minimum environmental standards for industries such as waste incineration and oil refining Regulatory Bodies - Her Majesty's Inspectorate of Pollution inspect and fine firms Extending Property Rights Tradable pollution permits, emissions trading, carbon trading
Kyoto Protocol An international agreement Signed by government representative in 1997 Designed to deal with climate change problems Developed nations agreed to reduce greenhouse gas emissions by 5% of 1990 levels by 2012 Allows carbon trading between industrialised countries Worryingly the US, who accounts for one third of all carbon emissions, withdrew from the agreement in 2001 Rapidly developing countries such as China and India were also not bound by the protocol, which seriously reduces the effectiveness of the agreement
http://www.bbc.co.uk/news/uk-11147780
Solar Panels Reducing negative externalities & thus reducing Market Failure Feed-in tariff Home owners receive 41.3p for every unit they generate, regardless of whether they use it or feed it back to the national grid Cost between £6k and 12k to buy and install Can earn home owners about £700 a year in feed back revenue plus £100 off electricity bills
http://www.bbc.co.uk/news/business-11149092
Key Terms Pollution Permit: a right to emit a given volume of waste or pollution into the environment Kyoto Protocol: an agreement made at a global summit meeting in Kyoto, Japan, to cut world carbon emissions
Past Exam Questions Specimen “Taxation and carbon trading can both be used to price carbon emissions” (Extract B, line 12) Explain how a government can use taxation and carbon trading to price carbon emissions (10 marks)
Up to 3 marks for relevant point explained: Using taxation: Identifying the sources Placing a monetary value on the emissions Imposing a tax on the polluter to internalise the external cost Using tax to increase the price and reduce consumption Using carbon trading: Imposing a ceiling or max limit on emissions for activity or firm Granting pollution permits Creating a market in which unused allowances can be traded MAX OF 7 MARKS IF ONLY 1 IS EXPLAINED
Past Exam Questions
Jan 2011 “Imperfect information may lead to market failure” Explain how imperfect information may result in the failure of markets for merit and demerit goods (15 marks)
Past Exam Questions Specimen Using the data and your economic knowledge, discuss whether government policies that aim to reduce the rate at which climate change is occurring benefit or harm the UK. (25 marks) Issues and areas for discussion include: Tax policies Regulation Carbon trading policies Effective policies require international co-operation with other governments Costs incurred in the absence of policies Costs created by the policies themselves Benefits experienced as a result of the policies Social versus private costs/benefits Government failure issues e.g. risk of too high carbon limits actually encouraging pollution
Past Exam Questions
Jan 2011 Discuss whether markets alone can be relied upon to reduce the problems of environmental pollution. (25 marks)
Past Exam Questions Jun 2011 “The UK’s strong reliance on landfill indicates the existence of widespread environmental market failure” (Extract B, lines 16-17) Using the data and your economic knowledge evaluate alternative methods of correcting market failure arising from waste disposal. (25 marks)
Past Exam Questions Jun 2010 “It is difficult to judge whether GM crops will boost productivity to feed the world and create social benefits or cause market failure through monopoly, environmental damage and adverse side effects on human health” (Extract B, line 38-40) Using the data and your economic knowledge, evaluate the view that the UK Government should support the production and use of GM crops. (25 marks)
