ALLOCATING PROPERTY RIGHTS TO REDUCE EXTERNALITIES Instead of

ALLOCATING PROPERTY RIGHTS TO REDUCE EXTERNALITIES Instead of

ALLOCATING PROPERTY RIGHTS TO REDUCE EXTERNALITIES Instead of controlling externalities directly through emissions fees and emissions standards, the government may take an indirect approach by assigning a property right: an exclusive privilege to use an asset. ALLOCATING PROPERTY RIGHTS

TO REDUCE EXTERNALITIES If no one holds a property right for a good or a bad, the good or bad is unlikely to have a price. ALLOCATING PROPERTY RIGHTS TO REDUCE EXTERNALITIES For many bads, such as pollution, and for some goods, property rights are not clearly defined. No one has exclusive

property rights to the air we breathe. Because of this lack of a price, a polluters of production is less than the full . COASE THEOREM According to the Coase Theorem (Coase, 1960), the optimal levels of pollution and output can result from bargaining between polluters and their

victims if property rights are clearly defined. COASE THEOREM To illustrate the Coase Theorem, consider a chemical plant and a boat rental company which share a small lake The chemical manufacturer dumps its waste by-products Smells bad but harmless otherwise

Pollution can only be reduced with decreases in the output Pollution hurts the boat rental firms business Other lakes nearby where people can rent boats Therefore, people rent only if the boat firm charges a lower price to compensate fully for the bad odor PROPERTY RIGHTS AND BARGAINING

PROPERTY RIGHTS AND BARGAINING COASE THEOREM If there are no impediments to bargaining, assigning property rights results in the efficient outcome at which joint profits are maximized. Efficiency is achieved regardless of

who receives the property rights. COASE THEOREM Who gets the property rights affects the income distribution. The property rights are valuable. The party with the property rights may be compensated by the other party. PROBLEMS WITH THE

COASE APPROACH First, if transaction costs are very high, it might not pay for the two sides to meet. The smaller the number of people, more likely will CT work. Second, if firms engage in strategic bargaining behavior, an agreement may not be reached. Third, if either side lacks information about

the costs or benefits or reducing pollution, a nonefficient outcome may occur. MARKETS FOR POLLUTION If high transaction costs preclude bargaining, we may be able to overcome this problem by using a market, which facilitates exchanges between individuals.

Getting back to emission tax SET THE PRICE OF SOCIAL DAMAGE Pigovian OR Green taxes In the early 20th century, Alfred Pigou suggested to add a tax on the market price to effectively solve the pollution problems Set the tax equation to the external

cost (externality) or marginal damage suffered by those affected SET THE PRICE OF SOCIAL DAMAGE Pigovian OR Green taxes 1. The idea is that a persons choices can be altered by imposing a green tax. The person continues to produce and pay the tax as long as the marginal benefits she

received from the output exceeds the tax 2. Ideally, if the green tax is set such that it reflects the equilibrium level of marginal damage, the person voluntarily selects the level of output that is the social optimum SET THE PRICE OF SOCIAL DAMAGE Double dividend with green taxes 1. Green taxes reduce pollution

2. Tax revenues can be used to offset other distortionary taxed (e.g., income tax) BAUMOL & OATES A tax on emissions can be the lowest-cost way of achieving a given level of emissions reduction Superior to Command and control Design standards the government tells firms how to control pollution Performance standard the government tells firms how much pollution they

can emit Abatement costs the cost of reducing emissions. Emissions can be reduced by several alternative means Installing end-of-pipe equipment (pollution treatment investments): methods used to remove already formed contaminants from a stream of air, water, waste, product or similar. These techniques are called 'end-of-pipe' as they are normally implemented as a last stage of a process before the stream is disposed of or delivered. Changing the production process

E.g., use of cleaner inputs / recycling waste Reducing output BAUMOL & OATES How can abatement costs change with the level of emissions reduction? We introduce marginal abatement cost curve (MAC)

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