The Pollution Game:The Pollution Game:A Classroom Demonstration Comparing the A Classroom Demonstration Comparing the

Relative Effectiveness of Pollution Control PoliciesRelative Effectiveness of Pollution Control PoliciesJay R. Corrigan

DemonstrationThe class is divided into three groups: the government regulatory agency, Ace Energy, and Deuce Petrochemical. The government’s task is to reduce pollution to the efficient level while minimizing the costs imposed on industry. The firms want to minimize total abatement costs. Each firm’s abatement cost is private information.

Government, in communication with firms free to respond strategically, designs a uniform standard for all firms, a system of emissions fees, and a cap-and-trade framework. Successively implementing these three strategies gives students a sense of the policies’ relative strengths in the presence of asymmetric information and resulting uncertainty on the part of government.

Topics for Discussion

MotivationStudents in undergraduate environmental economics courses learn that while pollution creates a negative externality, governments can employ a variety of policies in order to achieve economic efficiency, such as command-and-control, emissions fees, or tradable emissions permits.

But little time is generally spent discussing the relative strengths of these policy options in a world of asymmetric information and uncertainty. This demonstration is designed to illustrate the relative efficiency of various government policies aimed at internalizing negative externalities, as well as problems that arise due to heterogeneous abatement costs, asymmetric information, and strategic behavior on the part of regulated firms.

Do firms have an incentive to misstate their true abatement costs? How does this incentive differ across emissions fees and tradable permits? What can government do to minimize this kind of strategic behavior?

Why would you expect emissions fees to outperform tradable permits when marginal abatement costs are uncertain and relatively steep? Why would the opposite be true if the marginal benefit from abatement were relatively steep? Which scenario is more realistic for a pollutant like CO2?

Kenyon College

Likely Outcome

Estimating Abatement Cost Uniform Standard Tradable Permits Emissions Fees

MCAce

MCDeuce

AbatementAce

MCAce

AbatementDeuce

MCDeuce

Deadweight loss from inefficient

allocation of abatement.

Expect additional loss from imperfect choice of cap.

Both firms must pursue same level of

abatement

MBSociety

MCSocietyMCPerceived

Abatement

MC/MB

Tax

ATax

Deadweight loss from too much abatement

MBSociety

MCAce MCDeuce MCSocietyMCPerceived

Abatement

MC/MB

Perceived abatement costs may be greater than true abatement costs if

firms overstate their costs

Private information

Sum of firms’ curves

MBSociety

MCSocietyMCPerceived

Abatement

MC/MB

Deadweight loss from too little abatement

APermits