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Business in a Modern World. Markets, Firms, and the Role of Governments Legal systems; externalities and public goods; social security and distribution; imperfect competition. Firms and Governments: The Case of Environmental Policy - PowerPoint PPT Presentation
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1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
1
Business in a Modern World
Markets, Firms, and the Role of GovernmentsLegal systems; externalities and public goods; social security and distribution; imperfect competition.
Firms and Governments: The Case of Environmental PolicyPollution; emission standards, taxes and permits; EU emissions trading scheme.
The Global Economy I: Trade and LocationInternational trade; comparative versus competitive advantage; location and MNEs.
The Global Economy II: Capital and CurrenciesCapital mobility and market integration, exchange rates.
The Global Economy III: Policy and OrganisationsTrade policy and capital restrictions; the future of nations and organisations
Concluding Remarks on Business in a Modern World
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
2
• Part 1: Policy Approaches to Controlling Pollution
• 1. Introduction• 2. Main Objectives• 3. Efficient Policy• 4. Cost-Effective Policies• 5. ‘Dynamic’ Incentives• 6. Other Criteria• 7. Conclusions
Firms and Governments:Environmental Policy
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
3
1. Introduction
• Today’s topic: Policy approaches to control pollution
• Main issues:– government objectives– efficient & cost-effective policies– incentives to use/invent eco-friendly technologies– policy instruments and information requirement
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
4
2. Main Objectives
Now: Focus on pollution, i.e., flow of waste products from the economy back to the environment.
Pollution causes damage (externality) and benefits.
Damage includes loss of – use value– option value– existence value.
Take 15 minutes and give me examples! Is it possible to quantify that? Research it!
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
5
2. Main Objectives
• Cuts in pollution can be achieved by means of– less output/consumption
check on EUROSTAT GDP in 2008 and 2009 and CO2 emissions!http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/themes– abatement
• Main objectives of environmental policy:– efficiency– cost-effectiveness– incentives to use/invent eco-friendly technologies
Can you think of other objectives?
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
6
3. Efficient Policy
Efficient policy : cuts in polluting output
• Determining efficient pollution levels means balancing the trade-off between costs of & benefits from pollution.
• Efficiency condition:Marginal WTP for a product equals marginal social costs (marginal private plus external costs).
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
7
Price
Output
Efficient allocation Q*
Supply = Private marginal costs
Demand = Marginal WTP
Social marginal costs
Q*
Net benefit
3. Efficient Policy
cut
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
8
3. Efficient Policy
But: Environmental costs are ‘external’ costs.
No prices for pollution reflecting environmental scarcity.
Agents do not take environmental damage into account.
Inefficient high pollution levels in market equilibrium.
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
9
Price
Output
Efficient allocation Q* versus market allocation QM
QM
Supply = Private marginal costs
Demand = Marginal WTP
Social marginal costs
Q*
3. Efficient Policy
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
10
3. Efficient Policy
Possible efficient policy 1:
“Creating” a substitute for a market price by implementing an emission tax (or charge):
resulting tax payment per output unit = marginal damage at Q*
– Agents internalise environmental damage.
– “Modified” market outcome is efficient.
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
11
Price
Output
Efficient policy
Supply = Private marginal production costs + Tax
Demand = Marginal WTP
Social marginal costs
Q*= QP
Net benefit
3. Efficient Policy
QM
Supply = Private marginal costs
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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3. Efficient Policy
Efficient policy 2: increase in ‘abatement’
• Efficient pollution level (which we don’t know!) minimises the sum of – damage costs of pollution &– abatement (or control) costs of pollution.
• Marginal damage costs increase with the quantity of emissions.
• Marginal abatement costs increase with the quantity of emissions reduced (i.e., decrease with the quantity of emissions).
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
3. Efficient Policy
13
Quantity of emissions
Marginal costs
Marginal abatement costs
Marginal damage costs
Remember a damage has a certain benefit (cause)
Q*Emission Cuts
Q
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
3 Assignments
1) Damage includes lossGive examples! Is it possible to quantify that? Research it!
2) Cuts in pollution can be achieved by means ofless output/consumption check on EUROSTAT GDP in 2008 and 2009 and CO2 emissions!
3) Summarize different positions regarding pollution (proof!) from different stakeholders e.g.specific industries, parties,interest groups, NGOs etc.
14
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
emission cuts in emission
marg. costs
total costs
marg. damage
total damage
costs + damage
0 6 12 42 0 0 42
1 5 10 30 2 2 32
2 4 8 20 4 6 26
3 3 6 12 6 12 24
4 2 4 6 8 20 26
5 1 2 2 10 30 32
Q = 6 0 0 0 12 42 42
Example: Socially optimal outcome
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
emission cuts in emissio
n
marg. costs
total costs
marg. damage
total damage
costs + damage
0 6 12 42 0 0 42
1 5 10 30 2 2 32
2 4 8 20 4 6 26
3 3 6 12 6 12 24
4 2 4 6 8 20 26
5 1 2 2 10 30 32
Q = 6 0 0 0 12 42 42
Example: Socially optimal outcome
Cost to reduce the 6th unit of emissionsReduction costs of 5 emissions unitsAdditional damage caused by the 3rd emission unit
Cumulated damage
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
emission cuts in emission
marg. costs
total costs
marg. damage
total damage
costs + damage
0 6 12 42 0 0 42
1 5 10 30 2 2 32
2 4 8 20 4 6 26
3 3 6 12 6 12 24
4 2 4 6 8 20 26
5 1 2 2 10 30 32
Q = 6 0 0 0 12 42 42
Example: Socially optimal outcome
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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3. Efficient Policy
Efficiency condition:If pollution is efficiently allocated, then the marginal damage costs of pollution equal the marginal abatement costs.
Market allocation:
• Damage costs are externalities, firms’ abatement costs are private.
Firms do not abate REALITY if no policy applied
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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3. Efficient Policy
Possible efficient policy Pigouvian Tax:
Implementing an emissions tax which is equal to the marginal damage at the point where the marginal damage and abatement costs are identical.
Firms cut emissions as long as the marginal abatement costs are below the emissions tax.
Damage costs are internalised.
••
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
3. Efficient Policy
20
Quantity of emissions
Marginal costs
Marginal abatement costs
Marginal damage costs(socialized without any measure)
Q*
Tax
Emission CutsQ
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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3. Efficient Policy
Major Problem:– lack of information about marginal damage costs
(despite of a wide range of valuation methods)– lack of information about abatement costs &
differences in abatement costs between emission sources
– Difficulties in evaluating the efficient intertemporal use of resources
• Less ambitious policy assessment criterion:– cost-effectiveness
But what could be there reason for implementing it?
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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4. Cost-Effective Policies
“Exogenous” environmental targets determined in the political process.
Cost-effectiveness:An allocation is cost-effective if it meets a given environmental target in a manner that minimises total abatement costs.
Simple case (Example):– 2 emission sources– abatement costs differ between emission sources– given pollution target
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
emission
cuts in
emission
marg. costs
1
total costs
1
marg. costs
2
total costs
2
0 6 12 42 6 21
1 5 10 30 5 15
2 4 8 20 4 10
3 3 6 12 3 6
4 2 4 6 2 3
5 1 2 2 1 1
Q = 6 0 0 0 0 0
Question: Cost-effective outcome if total cuts = 6?
The case with 2 firms
To cut the sixth unit of emission costs 12 Units of money
To cut 6 emission units is necessary to minimize sum of total costs (1+2)
Cut in emission of firm 2
Cut in emission of firm 1
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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Emission cuts
Marginal costs
Emission cuts firm 2
Firm 1
Firm 2
6Cuts firm 1
4. Cost-Effective Policies
6
Initial situation without cuts
Initial situation without cuts
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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4. Cost-Effective Policies
Optimality condition:If an allocation is cost-effective (i.e., if it minimises total costs of pollution cuts), then the marginal abatement costs will be identical for all emission sources (here: polluting companies).
This principle can be applied to a case with countless companies e.g. the European trading scheme
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
4. Overview of instruments
26
Instruments to cut pollution
Market based
Tax (Pigouvian
tax)permits
Non-marketed
based
Emission standards
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
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4. Cost-Effective Policies
Command-and-control policy: Emission standards
• Emission standard:– legal limit on the quantity of emissions– allocation between different emission sources/firms?
• Any arbitrary allocation between sources/firms does– usually not equalise marginal abatement costs– not lead to cost-effective outcomes.
• For example: “equal” obligations to cut emissions
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
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4. Cost-Effective Policies
For example: “equal” obligations to cut emissions
- Read article (!)
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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4. Cost-Effective Policies
Marginal costs
Firm 1
Firm 2
Emission cuts
Cuts firm 2
Cuts firm 1 3 66
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
4. Cost-Effective Policies
30
See the difference
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
31
4. Cost-Effective Policies
Non-market based instrument:See example above (Emission standards):An “equal" cut of three emission units is not cost-effective.
• Problem:– Cost-effective standards require knowledge of
abatement costs that governments do not have. And even if they had, these costs are, due to dynamics, constantly changing !
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
32
4. Cost-Effective Policies
Market-Based Instruments I: Emission Tax (Pigou)• A tax on each unit of pollutant emitted, imposed by the
government.
• Emission tax serves as a substitute for the missing market price of the environment.
Response of firms:• Firms cut emissions as long as marginal the abatement
costs are below the emissions tax.
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
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4. Cost-Effective Policies
Result:
• If firms face an identical emission tax, they face identical incentives to cut emissions.
Marginal abatement costs are equalised across firms.
Abatement costs are “automatically” minimised;
• emission taxes are cost-effective.
• Note: Knowledge of abatement costs is not needed!
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
4. Cost-Effective Policies
34
Marginal costs
Tax
Firm 1
Firm 2
Total cuts
Emission cuts firm 2Cuts firm 1
Emission cuts
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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4. Cost-Effective Policies: Tax
Problems:– Iterative trial-&-error process is necessary to achieve
environmental targets (Was the tax imposement successful).
– Costs of legislative adjustments can be substantial.
Discussion: • What about using subsidies to install new technology
instead of taxes?
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
37
4. Cost-Effective Policies
Market-Based Instruments II: Emission Permits
• Transferable emission permits:• Permits that allow a firm to emit a specific amount of
pollutant over a specific time period; freely tradable.
Basic idea:• Generate a market for the environment by setting
aggregate “supply” of pollution
setting indirectly the price of the environment. What does the “price” depend on ?
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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4. Cost-Effective Policies
Response of firms:– Firms cut emissions & sell permits not needed as long
as the marginal abatement costs are below the permit price.
– Firms buy permits and emit more as long as the marginal abatement costs exceed the permit price.
Result:– Trade takes place until all firms’ marginal abatement
costs are equalised, and are equal to the permit price.– All firms face identical incentives to cut emissions.
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
4. Cost-Effective Policies: Permits
39
Marginal costs
Firm 1Firm 2
Total cuts
Emission cuts
Initial distribution of permits: Incentives to trade emission permits when marginal abatement costs differ
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
4. Cost-Effective Policies: Permits
40
Marginal costs
Price
Firm 1Firm 2
Total cuts
Equilibrium cuts firm 2Equilibrium Cuts firm 1
Emission cuts
Market equilibrium after trade in permit market
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
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4. Cost-Effective Policies
Abatement costs are ‘automatically’ minimised; emission permits are cost-effective.
Note:– Knowledge of abatement costs is not needed!– Cost-effectiveness is independent of initial permit
allocation.– No (costly) iterative trial-&-error process to meet
environmental targets.
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
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4. Cost-Effective Policies
Permits put into practice: How does this work?• initial allocation of permits:
– auctions– free allocation (grandfathering)
• Problems:– imperfect competition for permits– new market entries– transaction costs of trade
We will discuss this further !
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
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4. Cost-Effective Policies
Conclusion:Both market-based approaches, emission taxes & permits, are suitable to achieve cost-effectiveness.Permits enable the government to achieve directly pollution targets; taxes require a (costly) trial-&-error process.
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
5. ‘Dynamic’ Incentives
• ‘Dynamic’ incentives to use (and invent) eco-friendlier technologies in the case of emission taxes:– lower (marginal) abatement costs– lower tax payment– But: costs of switching to ‘new’ technology
• Example:– two technologies – ‘old’ and ‘new’ – available to a firm– new technology: lower (marginal) abatement costs– switching to new technology: fixed costs F
Example: Carbon Capture & Storage
44
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
5. ‘Dynamic’ Incentives
45
Quantity of Emissions
Marginal Costs
Qold
Tax
Emission Cuts
New technology
Old technology
Abatement costs
Tax payment
Q
Dynamic incentives :Example with tax
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
Business in a Modern World Fabian Girod
5. ‘Dynamic’ Incentives
46
Quantity of Emissions
Marginal Costs
Qnew
Price
Emission Cuts
New technology
Old technology
Cost reduction
Q
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
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5. ‘Dynamic’ Incentives
Result:• Firm chooses ‘new’ technology if cost reduction is greater
than costs of switching to ‘new’ technology F.
1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
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5. ‘Dynamic’ Incentives
Dynamic incentives to use (and invent) use eco-friendlier technologies in the case of emission permits:
– lower (marginal) abatement costs– revenues from selling permits (!)
Discussion:• Is there any difference between taxes and permits? • Why? Why not?• What about the dynamic incentives of emission standards?
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1. Introduction2. Markets, Firms
&the Role of Government
3. The case of environmental policy
4. Global Economy I
5. Global Economy II
6. Global Economy III
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5. ‘Dynamic’ Incentives
49
Quantity of Emissions
Marginal Costs
Qnew
Price
Emission Cuts
New technology
Old technology
Abatement costs
Costs of Permits
Q
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&the Role of Government
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6. Other Criterias argument for market-based approaches
• Response to economic cycles & growth– E.g. see following example of CO2 prices during the
economic crisis
• Distributional issues
• Ancillary benefits (‘double dividend’)
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&the Role of Government
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7. Conclusions
The message of economics:
• In principle, market-based instrument are cost-effective and provide dynamic incentives to use (and invent) eco-friendlier technologies;
• they are “superior” to traditional command-and-control approaches to controlling pollution.
• Let’s talk about political experiences in the next lesson!
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&the Role of Government
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Basic Reading
• Tietenberg (2007), Environmental Economics and Policy, 5th Edition, Boston et al.: Pearson – Addison Wesley, chapter 13.