Chapter 5

The Economics of
Environmental Quality

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 Learning Objectives
1. Distinguish between marginal and total damages and illustrate their
derivation graphically
2. Interpret the meaning of the marginal abatement cost curve and
illustrate graphically the distinction between marginal and total costs
of abatement
3. Illustrate graphically the determination of a socially efficient level of
pollution
4. Analyze shifts of marginal damages and marginal abatement cost
curves and the effects on efficient level of emissions and related
costs

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 Policy – Conceptual Basis
• A policy question: what steps should be undertaken to correct for market
failure, so as to achieve efficiency?
• Identifying the most appropriate level of environmental quality we ought to
try to achieve
• Dividing the task and costs of meeting environmental quality goals
• Distributing benefits and costs across society appropriately

• Effective public policy depends on good information on how economic and

environmental systems actually work - the scientific basis of environmental
policy:
• how firms and consumers normally make decisions in the market economy
• how residuals are emitted into the natural environment
• how these residuals behave in that environment to produce human and
nonhuman damages

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 Pollution Control – A General Model
• All pollution control activities are characterized by a simple trade-off
• on the one hand, reducing emissions reduces the damages that
people suffer from environmental pollution;
• on the other hand, reducing emissions takes resources that could
have been used in some other way.
• Example: a pulp mill is emitting production residuals into a river.
• The offending pulp mill could reduce the amount of effluent put in the
river by treating its wastes before discharge, as well as by recycling
certain mate-rials that currently just run out of the discharge pipe.
These activities can reduce the damages that people experience
when the environment is degraded.
• Act of reducing, or abating, some portion of its wastes will require
resources of some amount, the costs of which will affect the price of
the paper it produces. These abatement costs are the other side of
the basic pollution-control trade-off.
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 Pollution Damages

• Damages are all the negative impacts (on humans or ecosystem) that
users of the environment experience as a result of the degradation of
that environment.
• These negative impacts are of many types and, of course, will vary
from one environmental asset to another.
• Reduced damages = benefits of pollution abatement

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 TABLE 5.1 Estimated Primary Annual Benefits (Reduced
Damages) from Clean Air Act (CAA) Reductions of PM* and
Ozone

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 Damage Functions: Emission vs. Ambient

• A damage function shows the relationship between the quantity of a

residual and the damage that residual causes.
• There are two types of damage functions:
• Emission damage functions: These show the connection
between the quantity of a residual emitted from a source or group
of sources and the resulting damage.
• Ambient damage functions: These show the relationship
between the concentration of particular pollutants in the ambient
environment and the resulting damages.

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 Damage Functions: Marginal vs. Total

• Marginal damage (MD) functions show the change in damages

resulting from a unit change in emissions (or ambient concentration).
• Measured by the height of the MD function curve

• Total damage (TD) is the total amount of damage at each possible

emission level.
• Measured by the area under MD function curve

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 FIGURE 5.1 Representative Marginal Damage Functions

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 FIGURE 5.2 Anatomy of a Marginal Damage Function

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 Example: A Linear Marginal Damage Function

A single, non-accumulative pollutant that is uniformly distributed.

No threshold exists; that is, each marginal damage function begins at the
origin.

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 Changes in Damage Functions

• Some factors that move damage functions upward are:

a. Differences in population exposed, such as more people.

b. Different time periods, such as during the day versus after
sundown.
c. Different ecosystem conditions, such as a temperature inversion
that traps a pollutant over a city and produces relatively high
ambient concentrations.
d. New scientific estimates of increased pollution impact.

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 Abatement Costs

• Abatement costs are the costs of reducing the quantity of residuals

being emitted into the environment, or of lowering ambient
concentrations
• Abatement includes all the many ways there are of reducing
emissions: changes in production technology, input switching,
residuals recycling, treatment, abandonment of a site, and so forth.

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 EXHIBIT 5.1 The Abatement Cost Function for Cleaning Up
Boston Harbor 1

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 EXHIBIT 5.1 The Abatement Cost Function for Cleaning Up
Boston Harbor 2

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 Abatement Cost Functions

• Marginal abatement costs (MAC) show the added costs of achieving

a one-unit decrease in emission level, or alternatively the costs saved
if emissions are increased by a unit.
• Marginal cost curves rise from right to left, depicting rising marginal
costs of reducing emissions.
• If technology to reduce abatement improves, the MAC curve will shift
lower.
• The area under the marginal abatement cost curve, between
uncontrolled effluent at point and any particular effluent level, is equal
to the total abatement cost (TAC) of abating emissions to that level.
(Remember that we are reading the graph from right to left)

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 FIGURE 5.3 Representative Marginal Abatement Cost
Functions

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 FIGURE 5.4 Anatomy of a Marginal Abatement Cost Curve

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 Example: A Linear Marginal Abatement Cost Curve

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 Aggregate Marginal Abatement Costs

• Most environmental policies are aimed at controlling emissions from

groups of pollution sources, not just single polluters.
• We need to construct the overall, or aggregate marginal abatement
cost function for the collection of firms by adding together the
individual marginal abatement cost curves.
• How? Summing across horizontally on the individual marginal
abatement cost curves.
• Why? Equimarginal principle: To get the minimum (least cost)
aggregate marginal abatement cost curve, the aggregate level of
emissions must be distributed among the different sources in such a
way that they all have the same marginal abatement costs.

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 FIGURE 5.5 Aggregate Abatement Costs

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 The Socially Efficient Level of Emissions

• A trade-off that is inherent in the pollution phenomenon:

• Higher emissions expose society, or some part of it, to greater
costs stemming from environmental damages.
• Lower emissions involve society in greater costs in the form of
resources devoted to abatement activities.
• The efficient level of emissions is the level at which these two types
of costs exactly offset one another: MD = MAC => e*
• Equivalently, the efficient level of emissions e* is the unique point at
which total social costs from emission is minimized: Min(TD + TAC)
=> e*

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 FIGURE 5.6 The Efficient Level of Emissions

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 FIGURE 5.7 Efficient Emission Levels for Different Pollutants

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 Exercise

Suppose MAC = 60 - 4E and MD = 2E.

a) Draw a graph and solve for the efficient level of emissions e*, total
damages TD, total abatement cost TAC, and total social costs related
to emissions.
b) If there is no pollution control, what is the total social costs related to
emissions. How much of costs can be saved by moving to e*?
c) What is the total social costs related to zero emissions? How much of
costs can be saved by moving to e*?

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 Efficient Level of Emissions vs. Actual Level of Emissions

• The idea of the efficient level of emissions comes firmly under

normative economics, under the idea of what ought to be. e* is the
desirable target for public policy.
• Do not get this confused with the actual level of emissions. If the world
worked so that the actual level of emissions was always equal to, or
close to, the efficient level, we presumably would have no need to
worry about intervening with environmental policy of one type or
another. Of course it does not, which is why we must turn to public
policy.

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 Changes in the Efficient Level of Emissions

• The efficient level of emissions is subject to change as underlying

factors shift:
• Population growth and the results of scientific studies can shift MD
functions;
• Technological changes can cause MAC functions to shift.
• Note: the curve shift can represent same place at two different times
(change in time); it can also be used to compare two different places
at the same time (change in location)
• Curve shift => new intersection point = new efficient level of emissions

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 FIGURE 5.8 Changes in e*, the Efficient Level of Emissions

With the change in e*, what would happen to total social costs? TAC?

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 Enforcement Costs

• Emission reductions do not happen unless resources are devoted to

enforcement. To include all sources of cost, we need to add
enforcement costs to the analysis. Some of these are private, such
as added recordkeeping by polluters, but the bulk are public costs
related to various regulatory aspects of the enforcement process.
• The addition of enforcement costs increases e*.
• The vital importance of having good enforcement technology: Lower
marginal enforcement costs would move MAC + E closer to MAC,
decreasing the efficient emission level.
• Technical change in enforcement has exactly the same effect on the
efficient level of emissions as technical change in emissions
abatement.

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 FIGURE 5.9 Enforcement Costs

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 The Equimarginal Principle Applied to Emission Reductions

• If there are multiple sources of a particular type of pollutant with

differing marginal abatement costs, and if it is desired to reduce
aggregate emissions at the least possible cost, then emissions from
the various sources must be reduced in accordance with the
equimarginal principle: MAC1 = MAC2
• Another way of saying this is that for any particular amount of money
devoted to effluent reduction, the maximum quantitative reduction in
total effluent can only be obtained by following the equimarginal
principle.

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 TABLE 5.2 The Equimarginal Principal

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 The Equimarginal Principle Applied to Emission Reductions

Equiproportionate cutbacks: EA = EB
• Source A: $21,000 ($1,000 + $2,000 + $3,000 + $4,000 + $5,000 + $6,000)
• Source B: $56,000 ($2,000 + $4,000 + $6,000 + $10,000 + $14,000 +
$20,000)
• Total $77,000/week.

Equimarginal principle: MACA = MACB

• Source A: $39,000 ($1,000 + $2,000 + $3,000 + $4,000 + $5,000 + $6,000
+ $8,000 + $10,000)
• Source B: $22,000 ($2,000 + $4,000 + $6,000 + $10,000)
• Total $61,000/week.

An emission reduction plan that follows the equimarginal rule gives

emission reduction at minimum cost!

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