The Environment 16.1
16 c h a p t e r
WHAT ARE SOCIAL COSTS?
As we learned in Chapter 8, whenever an economic activity has benefits or costs that are shared by persons other than the demanders or suppliers of a good or service, an externality is involved. If the activity imposes costs on persons other than the demanders or suppliers of a good or service, it is said to have negative externalities. Put another way, negative externalities exist any time the social costs of producing a good or service exceed the private costs. Social costs refer to costs that spill over to other members of society. Private costs refer to costs incurred only by the producer of the good or service.
NEGATIVE EXTERNALITIES AND POLLUTION
The classic example of a negative externality is pollution.
When a steel mill puts soot and other forms of “crud” into the air as a by-product of making steel, it imposes costs on others not connected with the steel mill or with buying or selling steel. The soot requires nearby homeowners to paint their houses more often, entailing costs. Studies show that respiratory diseases are greater in areas with high air pollution, imposing substantial costs, often the shortening of life itself. In addition, the steel mill might discharge chemicals or overheated water into a stream, thus killing wildlife, ruining business for those who make a living fishing, spoiling recreational activities for the local population, and so on.
In deciding how much to produce, the steel makers are governed by demand and supply. They do not worry (unless forced to) about the external costs imposed on members of society, and in all likelihood, the steel makers would not even know the full extent of those costs.
Consider the hypothetical steel industry in Exhibit 1. It produces where demand and supply intersect, at output QPRIVATE and PPRIVATE. Let us assume
Negative Externalities and Pollution
s e c t i o n
16.1
_ What are social costs?
_ How are negative externalities internalized?
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PSOCIAL
MSC (MPC + External costs) S 5 MPC
QSOCIAL QPRIVATE
PPRIVATE
D
Price of Steel Quantity of Steel
0
The Effect of a Negative Externality
SECTION 16.1
EXHIBIT 1
The industry would normally produce where demand equals supply (where supply is equal to the marginal private costs), at output QPRIVATE and charging price PPRIVATE. If, however, the industry were forced to also pay those external costs imposed on others, the industry would produce where demand equals marginal social costs, at output QSOCIAL and price PSOCIAL.
Where firms are not forced to pay for negative externalities, output tends to be larger and prices lower than at the optimal output, where the marginal benefits to society (as measured by demand) equal the marginal costs to society.
This factory is clearly polluting the water downstream.
This creates a negative externality on those who fish downstream. It is possible that the people who fish could try to bargain with the factory, perhaps even pay them to pollute less. However, sometimes private bargaining does not work and the government can provide a solution through regulation or pollution taxes.
© GeoStock/PhotoDisc
that the marginal social cost of producing the product is indicated by the marginal social cost (MSC) curve, lying above the supply curve, which represents the industry’s marginal private costs (MPC).
The marginal social costs of production are higher at all output levels, as those costs include all of the industry’s private costs plus the costs that spill over to other members of society from the pollution produced by the industry—that is, the external costs.
At output QSOCIAL, the marginal social costs to society equal the marginal social benefits (as indicated by the demand curve) from the sale of the last unit of steel. At that output, the price of steel is
PSOCIAL. If the firm were somehow forced to compensate people who endure the costs of its pollution, the firm would produce at output QSOCIAL and price steel at PSOCIAL. In that case, we would say that the externalities were internalized, because each firm in the industry would now be paying the entire cost to society of making steel. When negative externalities are internalized, steel firms produce less output (QSOCIAL instead of QPRIVATE) and charge higher prices (PSOCIAL instead of PPRIVATE).
Optimal output occurs where the marginal social costs are equal to the marginal social benefits.
When firms do not pay all of the social costs they incur, and therefore produce too much output, there is also too much pollution. The output of pollution is directly related to the output of the primary goods produced by the firm.
MEASURING EXTERNALITIES
It is generally accepted that in the absence of intervention, the market mechanism will underproduce goods and services with positive externalities, such as education, and overproduce those with negative externalities, such as pollution. But the exact extent of these market misallocations is quite difficult to establish in the real world, because the divergence between social and private costs and benefits is often difficult to measure. For example, exactly how
CONSIDER THIS:
Are cellular phones a negative or positive externality? Some would say a negative externality because cell phones can distract drivers and cause accidents. On the other hand, cell phones may be a positive externality because drivers with cell phones can report accidents, crimes, stranded motorists, or drunken drivers.
Evidence is growing that motorists’ phone use poses a threat. One study, published in the New England Journal of Medicine in 1997, found that a driver talking on a cell phone is about four times as likely to get into a crash as a driver who isn’t. That makes driving while talking on a cell phone about as dangerous as driving with a blood-alcohol content at the legal limit.
Any nationwide push to force Americans to hang up and drive will run into a major roadblock: the U.S. telecommunications and auto industries.
Drivers are hugely important to the nation’s wireless phone industry, which has 95 million customers and collected about $40 billion in revenue last year. A recent NHTSA survey found that 44 percent of drivers have cell phones in the vehicle they normally drive, and General Motors Corp. says 70 percent of wireless calls are made from cars.
Worry about technology distracting drivers isn’t new. When windshield wipers were first introduced, critics fretted the devices would hypnotize drivers. And when car radios entered the market, opponents argued drivers wouldn’t be able to listen and concentrate on the road at the same time.
Some cell-phone advocates argued that using hands-free cell phones is a lot safer. The theory: The hands-free cell devices allow the driver to keep both hands on the wheel. And automakers plan to install systems that allow the phones to be used with special microphones and the car’s stereo speakers.
But several studies have concluded that talking on a hands-free phone is just as dangerous because it diverts the driver’s concentration from the road. “It’s not where your hands are, it’s where your head is that’s going to make a difference,” says Fran Bents, a former NHTSA official who supports legal restrictions.
SOURCE: Jeffrey Ball, “New Road Hazard—Driving While Cell-Phoning— Gets Federal Scrutiny.” The Wall Street Journal, July 14, 2000, p. B1.
CAR-PHONE RISKS FACE U.S. STUDY
By Jeffrey Ball
In The NEWS
© Steve Cole/PhotoDisc/Getty Images, Inc.
Negative Externalities and Pollution 339
By Chris Giles and Juliette Jowit
A new plan to ease traffic congestion in the city-center of London goes into effect Monday. Ken Livingstone, the mayor of London, has set a fee of about $8.10 for driving in the center of the capital on weekdays between 7 a.m. and 6:30 p.m. The aim of the plan, he says, is to ease congestion, not drive all the cars from the road.
Consider the following: • Vehicles in central London move no faster today than horse-drawn vehicles did 100 years ago.
• Even though only 15 percent of city-center travel is by car, the gridlock is endured by residents, commuters and businesses.
• Estimates of the economic costs—in lost time, wasted fuel and increased vehicle operating costs—tend to be in the range of 2 to 4 percent of the gross domestic product.
No city has attempted a scheme with anything like the size, scale and complexity of the London congestion charge: • About 50 million vehicle miles are traveled in the capital every day.
• Motorists will have to pay to drive into or inside an area roughly 10 square miles around the City (the financial district) and the West End.
• The zone will be policed by hundreds of fixed mobile cameras, which will automatically pick up vehicles’ license plates.
• Computers will match the registrations with a database of drivers who have paid in advance. Those who have not paid by midnight will be fined about $129.66.
Livingstone hopes the scheme will cut traffic in the zone by 10–15 percent, reduce delays by 20–30 percent, and raise about $210,700,000 a year to invest in public transport and road schemes.
SOURCE: Chris Giles and Juliette Jowit, “Economists Agree That the Best Way to Tackle the Growing Problem of Overcrowded Roads Is to Introduce Tolls at Peak Times,” Financial Times, February 13, 2003.
LONDON TOLLS ARE A TAXING PROBLEM FOR DRIVERS
If a road is crowded, it creates a negative externality. That is, when one person enters a road, it causes all other people to drive a little more slowly. Highway space is overused because we pay so little for it. At least at some particular times like at rush hours, if we charge a zero money price, there will be a shortage of highway space. A toll raises the price and brings the market closer to equilibrium.
340 CHAPTER SIXTEEN | The Environment
0 $2
Price Quantity of Freeway Space
DNONPEAK DPEAK Shortage
S
EXHIBIT 2
The supply of highway space is fixed in the short run, so the supply curve is perfectly inelastic. The demand varies during the day considerably. For example, the demand at peak hours (7 AM–8:30 AM and 4:00 PM–6:30 PM) is much higher that at nonpeak hours. At some price, the shortage during peak hours will disappear. In this example, it is at $2.
© Gary Knapp/AP Photo
much damage at the margin does a steel mill’s air pollution do to nonconsumers of the steel? No one really knows, because no market fully measures those costs. Indeed, the costs are partly nonpecuniary, meaning that no outlay of money occurs.
While we pay dollars to see the doctor for respiratory ailments and pay dollars for paint to repair pollution-caused peeling, we do not make explicit money payments for the visual pollution and undesirable odors that the mill might produce as a byproduct of making steel. Nonpecuniary costs are real costs and potentially have a monetary value that can be associated with them, but assessing that value in practical terms is immensely difficult.
While you might be able to decide how much you would be willing to pay to live in a pollution-free world, there is no mechanism at present for anyone to express the perceived monetary value of having clear air to breathe and smell. Even some pecuniary, or monetary, costs are difficult to truly measure: How much respiratory disease is caused by pollution and how much by other factors, like secondhand cigarette smoke? Continued progress by environmental economists in valuing these difficult damages is, however, being made.
After months of looking at houses he could not afford, Dean recently bought a home near the airport.
After living in his house for only a week, Dean was so fed up with the noise that he decided to organize a group of local homeowners in an effort to stop the noise pollution. Should Dean be compensated for bearing this negative externality? Because few people want to live in noisy areas, housing prices and rents in those areas are lower, reflecting the cost of the noise in the area. As a result, fewer people competed with Dean for the purchase of his house relative to houses in quieter neighborhoods, so it is likely he did not pay as much as he might have in another area. Because Dean paid a lower price for living in a noisier area, he has already been compensated for the noise pollution.
NEGATIVE EXTERNALITIES
USING WHAT YOU'VE LEARNED
A Q
Negative Externalities and Pollution 341
1. Social costs are those that accrue to the total population; private costs are incurred only by the producer of the good or service.
2. If the industry were somehow forced to compensate people who endure the costs of pollution, we would say that the industry had internalized the externality.
3. When negative externalities are internalized, the industry produces less output at a higher price.
4. Optimal output occurs when marginal social benefits are equal to marginal social costs.
1. What is the difference between private and social costs?
2. Why do decision makers tend to ignore external costs?
3. How can internalizing the external costs of production move us closer to the efficient level of output?
4. Why is it particularly difficult to measure the value of external costs or benefits?
s e c t i o n c h e c k
© Matt Lindsey/Nonstock/PictureQuest
While measuring externalities, both negative and positive, is often nearly impossible, that does not necessarily mean that it is better to ignore the externality and allow the market solution to operate. As already explained, the market solution will almost certainly result in excessive output by polluters unless some intervention occurs. But what form should the intervention take?
COMPLIANCE STANDARDS
One approach to dealing with externalities is to require private enterprise to produce their outputs in a manner that would reduce negative externalities below the amounts that would persist in the absence of regulation. For example, the Environmental Protection Agency (EPA) was established by the Clean Air Act of 1970 to serve as a watchdog over the production of goods and services in areas where externalities, especially negative externalities, exist.
The EPA’s main duty is to enforce environmental standards.
Using the compliance standards approach, the EPA identifies and then enforces a standard equal to the maximum amount of pollution that firms can produce per unit of output per year. To be effective in pollution reduction, of course, these standards must result in less pollution than would exist in the absence of the compliance standards. The standards, then, force companies to find less pollution intensive ways of producing goods and services. Or in the case of consumer products that pollute—such as automobiles, for example—manufacturers have been forced to reduce the emissions from the products themselves.
Evidence exists that pollution has declined since 1970, although this does not measure exactly what the EPA’s impact has been, as other things were also changing. However, it does appear that the compliance standards approach to limiting key pollutants has led to a reduction in pollution levels. For example, the phasing out of leaded gasoline, which started in 1984, has had a dramatic effect on the levels of lead in our atmosphere.
WHY IS A CLEAN ENVIRONMENT NOT FREE?
In many respects, a clean environment is no different from any other desirable good. In a world of scarcity, we can increase our consumption of a clean environment only by giving up something else. The problem that we face is choosing the combination of goods that does the most to enhance human wellbeing.
Few people would enjoy a perfectly clean environment if they were cold, hungry, and generally destitute. On the other hand, an individual choking to death in smog is hardly to be envied, no matter how great his or her material wealth.
Only by considering the additional cost as well as the additional benefit of increased consumption of all goods, including clean air and water, can decisions on the desirable combination of goods to consume be made properly.
Public Policy and the Environment
16.2
_ What are compliance standards?
_ What is the “best” level of pollution?
_ What is a pollution tax?
_ What are transferable pollution rights?
Los Angeles led the nation in most-improved air quality, reducing its smog levels by 85 percent since the 1980s. In the Los Angeles area, the number of days in which ozone pollution exceeded federal standards dropped from an average of 154.3 per year during the early 1980s to just 23 days a year in the late 1990s—a dramatic 85 percent reduction. The average number of high-ozone days in the Riverside–San Bernardino area, usually the most polluted area in Southern California, dropped from 158 to 53 days over two decades—a 66 percent reduction.
© PhotoDisc
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THE COSTS AND BENEFITS OF POLLUTION CONTROL
It is possible, even probable, that pollution elimination, like nearly everything else, is subject to diminishing returns. Initially, a large amount of pollution can be eliminated fairly inexpensively, but getting rid of still more pollution may prove more costly. Likewise, it is also possible that the benefits from eliminating “crud” from the air might decline as more and more pollution is eliminated. For example, perhaps some pollution elimination initially would have a profound impact on health costs, home repair expenses, and so on, but as pollution levels fall, further elimination of pollutants brings fewer marginal benefits.
The cost-benefit trade-off just discussed is illustrated in Exhibit 2, which examines the marginal social benefits and marginal social costs associated with the elimination of air pollution. In the early 1960s, we had few regulations as a nation on pollution control, and as a result, private firms had little incentive to eliminate the problem. In the context of Exhibit 2, we may have spent Q1 on controls, meaning that the marginal social benefits of greater pollution control expenditures exceeded the marginal costs associated with having the controls. Investing more capital and labor to reduce pollution is efficient in such a situation.
Optimum pollution control occurs when Q* of pollution is eliminated. Up to that point, the benefits from the elimination of pollution exceed the marginal costs, both pecuniary and nonpecuniary, of the pollution control. Overly stringent compliance levels force companies to control pollution to the level indicated by Q2 in Exhibit 2, where the additional costs from the controls far outweigh the environmental benefits. It should be stated, however, that increased concerns about pollution have probably caused the
Under the Clean Air Act, EPA establishes air quality standards to protect public health, including the health of “sensitive” populations such as asthmatics, children, and the elderly. EPA also sets limits to protect public welfare, including protection against decreased visibility and damage to animals, crops, vegetation, and buildings. EPA has set national air quality standards for six principal pollutants (also referred to as criteria pollutants): carbon monoxide (CO), lead (Pb), nitrogen dioxide (NO2), ozone (O3), particulate matter (PM), and sulfur dioxide (SO2). Each year EPA examines changes in levels of these pollutants over time and summarizes the current air pollution status.
EPA tracks trends in air quality based on actual measurements of pollutant concentrations in the ambient (outside) air at monitoring sites across the country. Monitoring stations are operated by state, tribal, and local government agencies as well as some federal agencies, including EPA. Trends are derived by averaging direct measurements from these monitoring stations on a yearly basis. Exhibit 1 shows that the air quality based on concentrations of the principal pollutants has improved nationally over the last 20 years (1983–2002). The most notable improvements are seen for lead, carbon monoxide, and sulfur dioxide with 94, 65, and 54 percent reductions, respectively.
Between 1970 and 1999, total emissions of the six principal air pollutants decreased 31 percent. This dramatic improvement occurred simultaneously with significant increases in economic growth and population. The improvements are a result of effective implementation of clean air laws and regulations, as well as improvements in the efficiency of industrial technologies.
Despite great progress in air quality improvement, approximately 62 million people nationwide still lived in counties with pollution levels above the national air quality standards in 1999. SOURCE: http://www.epa.gov/oar/aqtrnd99/brochure/brochure.pdf
REDUCTIONS IN AIR POLLUTION LEVELS
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Pollutant Change
CO (carbon monoxide) 265% Pb (lead) 294 NO2 (nitrogen oxide) 221 O3 (ozone) 1-hr 222 8-hr 214 PM10 (particulate matter) 222* SO2 (sulfur dioxide) 254
Percentage Change in Air Quality, 1983–2002
SECTION 16.2
* 1993–2002.
Year-to-year air quality trends can also be affected by atmospheric conditions and the location of air quality monitors, which are usually located in urban areas. That is, air quality emissions are affected by urban emissions and tend to be different than nationwide emissions. Particulate matter (PM) is a general term used for particles in the air, some large enough to look like smoke or soot.
Sources for PM include wood-burning stoves and fireplaces, motor vehicles, power generators, unpaved roads, and windblown dust. About 60 percent of the CO emissions come from autos. Lead levels dropped considerably when leaded gasoline was phased out. SO2 and NO2
contribute to acid rain. Ground-level ozone is the primary component of smog.
marginal social benefit curve to shift to the right over time, increasing the optimal amount of pollution control. Because of measurement problems, however, it is difficult to state whether we are generally below, at, or above the optimal pollution level.
HOW MUCH POLLUTION?
It is practically impossible to get widespread agreement on what the appropriate level of pollution should be. Indeed, if we did have the appropriate level, about half of the people would think it too little and half would think it too much. People with different preferences and situations are simply going to have different ideas about the costs and benefits of pollution abatement. For example, consider a community that contains a college and an oil refinery, the latter emitting large quantities of nauseating and potentially noxious fumes into the atmosphere. Who do you think is most likely to participate in a protest favoring stringent pollution controls on the refinery: the college students or the townspeople? It is a safe bet that the answer is the college students. In fact, the college students may want to shut down the refinery altogether. Why is this? One may think that college students are more aware of and sensitive to the environmental quality of the community. Maybe. But the long-term residents of the community, those who plan to stay there and raise their children there, are certainly at least as concerned about the air quality in their community. Indeed, they may well be more concerned about local pollution than the college students who, after all, will typically live in the community only until they graduate. The primary difference between the townspeople and the students is probably not in the desire for a clean environment but the fact that the cost of cleaning up the environment will fall almost entirely on the townspeople. It is their jobs, incomes, and retirement plans that will be jeopardized by strict pollution control requirements or the closing of the refinery. The students will not have to pay this cost, because their job prospects and current income will be quite independent of the profitability of the local refinery. Not surprisingly, then, it is the students who will be most eager to either shut down the refinery or clean it up, because they will reap many of the benefits and pay few of the costs. The townspeople will be a little less enthusiastic about environmental purity because they are likely to pay for much of it.
The point is not to decide which group is right or wrong. Both the students and the townspeople are quite rational, given the different situations they face. The purpose here is to emphasize that controversy is sure to arise when a community of people share a common, or public, good (or bad). Conflicts are inevitable because different people have different preferences and face different costs. This explains much of the controversy that surrounds environmental issues. Controversy over environmental protection would largely disappear if everyone could pay for and consume a preferred level of environmental quality, independent of the level paid for and consumed by others, in much the same way that individuals can choose either hamburgers or tofu burgers—each getting the private goods they want. But there is no way to completely avoid this type of controversy for public goods like air quality or national defense. It should be recognized, however, that one way people often moderate controversies of this type is by sorting themselves into relatively homogeneous groupings. Communities that contain people with similar backgrounds, preferences, and circumstances are more likely to avoid socially divisive controversies than are communities containing more diverse populat...
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