Unit 3.2.(1) Market Failure and Public Intervention PDF

Unit 3. Market failure and public intervention Roles of Government Market Failures (2º reason for government intervention): when the allocation of goods and services by the free market does not achieve the efficient allocation Market power (non-competitive markets) Monop...

Unit 3. Market failure and public intervention Roles of Government Market Failures (2º reason for government intervention): when the allocation of goods and services by the free market does not achieve the efficient allocation Market power (non-competitive markets) Monopoly (1 producer) Oligopoly (few producers) Monopsony (1 buyer – labor market typically) Cartels (collaboration to set prices) Product differentiation Non-existence of markets Asymmetric Information Public Goods Externalities 1  Unit 3. Market failure and public intervention 2.3. EXTERNALITIES Positive and Negative Externalities Externalities arise if the choices of production or consumption of some agents have collateral effects on other agents u Negative externality: the impact is adverse u Positive externality: the impact is beneficial 2  Unit 3. Market failure and public intervention Negative Externalities PRODUCTION CONSUMPTION u Environmental pollution uSmoking u Noise uDrinking u Traffic 3  Unit 3. Market failure and public intervention Positive Externalities PRODUCTION CONSUMPTION u Research in new uVaccination technologies uEducation u Improving historical buildings 4  Unit 3. Market failure and public intervention Externalities in production a) Externalities in production: negatives In the absence of externalities the quantity produced and consumed when the market is in equilibrium, it is efficient: It maximizes total surpluses If there is a negative externality (e.g. pollution of aluminum factories), the social cost of the production of aluminum is higher than the private cost : The social cost = private cost of the producers PLUS the cost of pollution. The production of aluminum will be higher than the optimum. 5 Negative externalities. E.g. the aluminum market... Price of aluminum Normally… Supply (private cost) Equilibrium Demand (private value/benefit) 0 Q market Quantity of aluminum 6 Negative externalities and social optimum … Aluminum Price Supply (marginal private cost) Equilibrium Demand (marginal private benefit) 0 QMarket Quantity of Aluminum 7 Negative externalities and social optimum … Aluminum Price MPC (marginal private cost) Equilibrium MPB (marginal private benefit) 0 QMarket Quantity of Aluminum 8  Negative externalities and social optimum … Aluminum Price MPC (marginal private cost) MD/MEC: Marginal Damage or Marginal Equilibrium External Cost MPB (marginal private Benefit) 0 QMarket Quantity of Aluminum 9 Negative externalities and social optimum … Aluminum Cost of MSC Price contamination (marginal social cost) MPC (marginal private cost) Equilibrium MPB (marginal private benefit 0 QMarket Quantity of Aluminum 10 Negative externalities and social optimum … Aluminum Cost of MSC Price contamination (marginal social cost MPC (marginal private cost) Equilibrium MPB (marginal private benefit 0 QMarket Quantity of Aluminum 11 Negative externalities and social optimum … Aluminum Cost of MSC Price contamination (marginal social cost) MPC (marginal private cost) Optimum Equilibrium MPB (marginal private Benefit) 0 QOptimal QMarket Quantity of Aluminum 12  Negative externalities and social optimum … Costs do not need to be constant MSC Aluminum Price MPC Optimum Equilibrium MEC/MD MPB 0 Q Optimum Q Market Quantity of Aluminum 13  Unit 3. Market failure and public intervention b) Externalities in production: positives In absence of externalities, the quantity produced and consumed when the market is in equilibrium is efficient: It maximizes the total surplus If there is a positive externality (e.g. production of robots), the social cost of producing robots is smaller than the private cost: The social cost = private cost MINUS the benefits of the diffusion of a new technology. The production of robots will be smaller than the optimum. 14  Positive externalities: example of the market for robots production of robots generates positive externalities because the diffusion of new technologies can benefit other producers. Price Supply = MPC of a robot Normally… Equilbrium Demand = MPB 0 Q Market Quantity of robots 15  Positive externalities and social optimum… Price Value of MPC of a robot the diffused technology MSC Equilibrium Optimum MPB 0 Q Market Q Optimum Quantity of robots 16  Unit 3. Market failure and public intervention To sum up….Externalities in production The social cost is different than the private cost. If the externality is negative ➔ social cost > private cost. If the externality is positive ➔ social cost < private cost. Examples: a) The production of aluminum generates negative externalities because the social cost includes the production cost plus the cost of contamination. b) The production of robots generates positive externalities because the diffusion of new technologies can benefit other producers. 17  Unit 3. Market failure and public intervention Externalities in consumption The social value differs from the private value. Negative externality: the social value private value. Examples: a) Alcohol consumption generates negative externalities because it generates health problems, delinquency, violence, etc. b) Education generates positive externalities because a higher education goes hand in hand with higher productivity of workers. 18  Externalities in consumption... (a) Negative externality in consumption: (b) Positive externality in consumption: smoking→ LESS social value Vaccination: HIGHER social value Price of alcohol Price of Supply Education Supply MPC MPC Demand MSB MPB Social value MSB Demand Social value MPB 0 Q Q Quantity 0 Q Q Quantity of optimal market of alcohol market optimal Education 19  Unit 3. Market failure and public intervention Externalities and economic welfare In presence of externalities, the market fails and generates a loss of welfare: When producers and consumers do not take into account the external effects of their choices, they do not produce the optimal quantity. Negative externalities : Qmarket > Qoptimal Positive externalities : Qmarket < Qoptimal 20  Unit 3. Market failure and public intervention Solutions to Externalities How to induce agents to take into account the external effect of their choices and to get to the social optimum? 21  Unit 3. Market failure and public intervention Solution 1. Property rights Markets fail to provide resources efficiently when the property rights are not well established It is said that a property right is not well established when some item of value does not have an owner with the legal authority to control it. Examples: Smoking – who has the right (smoker to smoke, or non-smoker to clean air) Polluting factory upstream from a fisheries When the absence of property rights causes a market failure, the government can potentially solve the problem. 22  Unit 3. Market failure and public intervention Solution 2. Internalization of Externalities One step to solve the externalities is to internalize them : Internalization of externalities: modification of incentives to make the agents take into account the external effect of their choices. Having to pay for the damages means that the business person considers the damage to the environment as a private cost. In other words, the external effect is internalized → It is an efficient and equitable solution. Internalization can take place in two ways: 2.1.Private solutions. 2.2.Public solutions. 23  Unit 3. Market failure and public intervention 2.1. Private Solutions to Externalities The Coase Theorem DEFINITION: If all property rights are well defined and private parties can bargain without cost over the allocation of resources, they can solve the problem of the externalities on their own. → Whatever the initial distribution of rights, the interested parties can always reach an agreement in which everyone is better off and the outcome is efficient. 24  Unit 3. Market failure and public intervention Example The Coase theorem Owner of a noisy bar (B) and a neighbor (N). Value for B is 500 €; Cost of the noise for N is 800 €. If the bar is open : total welfare 500-800=-300. If the bar is closed : total welfare =0 (0>-300). Let’s assume that the law allows the bar to open : If N offers 700 € to B to keep the bar closed, B accepts and the bar remains closed. Welfare of N= -700(>-800); welfare of B 700(>500). 25  Unit 3. Market failure and public intervention Example The Coase theorem Owner of a noisy bar (B) and a neighbor (N). Value for B is 500 €; Cost of the noise for N is 800 €. If the bar is open : total welfare 500-800=-300. If the bar is closed : total welfare =0 (0>-300). Let’s assume that the law allows the bar to open : If N offers 700E to B to keep the bar closed, B accepts and the bar remains closed. Welfare of N= -700(>-800); welfare of B 700(>500). Let’s assume that the law does not allow the bar to open : The result does not change because B can not make any offer to N which is acceptable for both. ◆Note: The private solution fails when transaction costs are too high. 26  Unit 3. Market failure and public intervention 2.2. Public solutions to solve externalities The government tries to solve the problem of the externalities with : Policies based on the market: Pigouvian taxes (to correct the negative externalities) and subsidies (to correct the positive externalities). Tradable permits (cap-and-trade mechanisms). Measures of command-and-control: To forbid some activities (avoid pollution above certain level) or to make some activities compulsory (sanitary personnel has to be vaccinated). 27  Unit 3. Market failure and public intervention Public policies to solve externalities (1) Pigouvian Tax a. Pigouvian subsidy (2) Emissions Fees (3) Cap and Trade (4) Command and Control Regulation a. Technology standard b. Performance standard 28  Unit 3. Market failure and public intervention Public polities to solve externalities (1) Pigouvian Tax: to fix a tax on each unit of pollution a. Pigouvian subsidy (2) Emissions Fees (3) Cap and Trade (4) Command and Control Regulation a. Technology standard b. Performance standard 29  Unit 3. Market failure and public intervention (1) Pigouvian taxes The concept was developed by economist Arthur Pigou, who argued that imposing a tax proportional to the social cost of the externality could align private interests with social welfare. The idea is that by taxing those who generate negative externalities, harmful activity is discouraged or at least its harmful effects are reduced. For example: if a factory emits pollutants into the air, a Pigouvian tax on each unit of pollution it generates would force the factory to internalize the cost of the pollution it imposes on society. 30 Pigouvian taxes: Polluter Problem If the Environmental Protection Agency wants to reduce pollution, it can… P First, the naturally occurring outcome in the market MPC=S MPB=D Q1 Q Plastics made with pollution byproduct in process 31 Pigouvian taxes: Polluter Problem But, we have some external damage being P created (pollution). As drawn, pollution damage increases per unit with each plastic product produced MPC MDamage MPB Q1 Q Plastics made with pollution byproduct in process 32 Pigouvian taxes: Polluter Problem P But, we have some external damage being created (pollution). As drawn, pollution damage increases per unit with each plastic product produced MPC MD MPB Q1 Q Plastics made with pollution byproduct in process 33 Pigouvian taxes: Polluter Problem P MSC = MPC + MD We can add that damage to the MPC to get the MSC MPC MD MPB Q1 Q Plastics made with pollution byproduct in process 34 Pigouvian taxes: Polluter Problem P MSC = MPC + MD We can add that damage to the MPC to get the MSC MPC MD MPB Q1 Q Plastics made with pollution byproduct in process 35 Pigouvian taxes: Polluter Problem P MSC = MPC + MD The intersection of MSC and MPB (marginal private benefit) gives the optimal Q MPC MD MPB Q* Q1 Q Plastics made with pollution byproduct in process 36 Pigouvian taxes: Polluter Problem P Goal: How do we set a tax to get the MSC = MPC + MD polluters’ to naturally choose Q*? Pigouvian Tax: a tax on each unit of polluters’ output in an amount equal MPC to the MDamage at the optimum MD MPB Q* Q1 Q Plastics made with pollution byproduct in process 37 Pigouvian taxes: Polluter Problem P Goal: How do we set a tax to get the MSC = MPC + MD polluters’ to naturally choose Q*? Pigouvian Tax: a tax on each unit of polluters’ output in an amount MPC equal to the MD at the optimum c MD d MPB Q* Q1 Q Plastics made with pollution byproduct in process 38 Pigouvian taxes: Polluter Problem P Goal: How do we set a tax to get the MSC = MPC + MD polluters’ to naturally choose Q*? MPC2= MPC+cd Pigouvian Tax: a tax on each unit of polluters’ output in an amount MPC equal to the MD at the optimum c MD d MPB Q* Q1 Q Plastics made with pollution byproduct in process 39 Pigouvian taxes: Polluter Problem P Do you see why this works? MSC = MPC + MD MPC2 MPC c MD d MPB Q* Q1 Q Plastics made with pollution byproduct in process 40 Pigouvian taxes: Polluter Problem P Do you see why this works? MSC = MPC + MD A: Now, MPC2=MPB at Q* MPC2 MPC c MD d MPB Q* Q1 Q Plastics made with pollution byproduct in process 41 Pigouvian taxes: Polluter Problem P MSC = MPC + MD The pigouvian tax is height c-d The tax revenue is the area of rectangle abcd MPC’ MPC c a b MD d MPB Q* Q1 Q Plastics made with pollution byproduct in process 42 Pigouvian subsidy: Polluter Problem P MSC = MPC + MD Instead of charging the polluter for polluting, we could alternatively pay them not to pollute (less popular method, but still works) MPC MD MPB Q* Q1 Q Plastics made with pollution byproduct in process 43 Pigouvian subsidy: Polluter Problem P Just like Pigouvian tax, the subsidy size is the MSC = MPC + MD MDamage at Q*. In the case of the subsidy, the polluter is paid that amount for every unit Q reduced from Q1 MPC MD MPB Q* Q1 Q Plastics made with pollution byproduct in process 44 Pigouvian subsidy: Polluter Problem P This means that for each unit of Q the MSC = MPC + MD producer produces, they miss out of exactly the amount of the subsidy. It’s like giving someone a lump sum and MPC taxing it away MD MPB Q* Q1 Q Plastics made with pollution byproduct in process 45 Pigouvian subsidy: Polluter Problem P MSC = MPC + MD This means that for each unit of Q that the polluter produces, they miss out of exactly the amount of the subsidy. MPC2 MPC This works exactly like the tax did. MD MPB Q* Q1 Q Plastics made with pollution byproduct in process 46  Unit 3. Market failure and public intervention Pigouvian subsidy: Polluter Problem In reality, Pigouvian subsidies are not used often because: (1) They require resources to implement (2) They require some barrier to entry into the market or you could see producers entering (or starting high) to take advantage of the subsidy 47  Unit 3. Market failure and public intervention Pigouvian subsidy: Polluter Problem In reality, Pigouvian subsidies are not used often because (1) They require resources to implement (2) They require some barrier to entry into the market or you could see producers entering (or starting high) to take advantage of the subsidy Pigouvian tax is much better. However: (1) It is not always easy to determine how much damage each tonne of CO₂ does to the climate (e.g.) (2) Reactions from companies or consumers: Some industries might resist these taxes or seek to evade them. 48  Unit 3. Market failure and public intervention Public policies to solve externalities (1) Pigouvian Tax a. Pigouvian subsidy (2) Emissions Fees (3) Cap and Trade (4) Command and Control Regulation a. Technology standard b. Performance standard 49 (2) Emission Fees: Polluter Problem Emissions fee: a tax levied on each unit of emissions P rather than on each unit of output. MC to producer of reducing pollution MSB of pollution reduction 0 Costs and Benefits of pollution reduction Pollution in production of plastics Reduction (good thing)50 Emission Fees: Polluter Problem Costs and Benefits of pollution reduction P in production of plastics MC to producer of reducing pollution More Efficient point Less reduction reduction improves improves efficiency efficiency MSB of pollution reduction: new technology, cleaner inputs… 0 e* Reduction Starting place = Optimal reduction (good thing) no reduction in emissions 51 Emission Fees: Polluter Problem Costs and Benefits of pollution reduction P in production of plastics MC to producer of reducing pollution None of these benefits (but all of the costs) belong to the producer, so he will naturally choose zero reduction MSB of pollution reduction 0 e* Reduction Starting place = Optimal reduction (good thing) no reduction in emissions 52 Emission Fees: Polluter Problem The government levies an emissions fee that charges P f* for each unit of pollution, where f* is the MSB of pollution reduction at the efficient level e* MC to producer of reducing pollution f MSB of pollution reduction 0 e* Pollution f= fee for each unit of emissions produced (tax directly on emissions) Reduction f=MB to producer of reductions (gets (f) back for each unit reduced) (good thing) 53  Unit 3. Market failure and public intervention Emission Fees: Polluter Problem Advantages of Emission Fees over a Pigouvian tax: (1) The reduction in emissions can come from a reduction in Q new technology pollution filters a change in inputs… Emission Fees will arrive at e* reductions in emissions It does this without necessarily reducing Q (2) When there are multiple “polluters”, it also can also account for different costs of reducing emission across companies. An emissions fee will naturally result in the most cost effective reduction. 54 Two companies: both creating pollution in production process € € MC2 MC1 0 0 pollution pollution reduction reduction 55  Two companies: both creating pollution in production process € € MC2 MC1 0= Max=90 0 Max=90 pollution pollution 90 emissions reduction reduction They both start with 90 units of pollution 56  Two companies: both creating pollution in production process € € MC2 MC1 0= Max=90 0 Max=90 pollution pollution 90 emissions reduction reduction They both start with 90 units of pollution At this amount, they face very different MCs of pollution reduction MC2>MC1 57  Two companies: both creating pollution in production process € € MC2 MC1 0= Max=90 0 Max=90 pollution pollution 90 emissions reduction reduction They both start with 90 units of pollution At this amount, they face very different MCs of pollution reduction MC2>MC1 Assume the efficient amount of pollution in society is 80 units We are currently at 180, and therefore need to reduce pollution by 100 units 58  Two companies: both creating pollution in production process € € MC2 MC1 0= Max=90 0 Max=90 pollution pollution 90 emissions reduction reduction Q: how to divide up the total reduction in emissions (100)? 59  Two companies: both creating pollution in production process € € MC2 MC1 0= 50 Max=90 0 50 Max=90 pollution pollution 90 emissions reduction reduction Q: how to divide up the total reduction in emissions (100)? Let’s start with 50-50… 60  Two companies: both creating pollution in production process € € MC2 MC1 0= 50 Max=90 0 50 Max=90 pollution pollution 90 emissions reduction reduction Let’s start with 50-50… We reach the desired reduction of 100 units BUT not at the lowest cost possible It is more expensive for company 2 to reduce 50 units than for company 1 61  Two companies: both creating pollution in production process € € MC2 Less More MC1 reduction reduction 0= 50 Max=90 0 50 Max=90 pollution pollution 90 emissions reduction reduction Notice: If company 1 reduced one more unit of pollution and company 2 reduced one less unit of pollution, we would be at the same total number, but at a lower cost (due to the different MCs of reduction) 62  Two companies: both creating pollution in production process € € MC2 MC1 0= 50 Max=90 0 50 Max=90 pollution pollution 90 emissions reduction reduction Cost Effective: when an outcome is achieved at the lowest possible cost. Total costs are minimized (when MCs equal) Why? Just like trade, no more room for improvement 63  Two companies: both creating pollution in production process € € MC2 MC1 f 0= 75 Max=90 0 25 Max=90 pollution pollution 90 emissions reduction reduction Steps: 1. Restrict MCs to be equal 2. Find the option where they add up to the desired reduction 3. Set emissions fee there 64  Two companies: both creating pollution in production process Recall that the emissions fee acts € like a MB of reduction since the € MC2 polluting producer gets back (f) for each unit reduced. MC1 f 0= 75 Max=90 0 25 Max=90 pollution pollution 90 emissions reduction reduction Each producer will naturally choose to reduce emissions to f=MB=MC As long as f>MC, it is worthwhile for the producer to reduce emissions 65  Two companies: both creating pollution in production process € € MC2 Company 1’s tax payment MC1 f Company 2’s tax payment 0= 75 Max=90 0 25 Max=90 pollution pollution 90 emissions reduction reduction Note: Both of them were equal polluters and face the same fee, BUT for one it is relatively more worthwhile to reduce emissions than for the other. 66 Emission Fees: Polluter Problem P MSC to producers of reducing pollution f MSB of pollution reduction 0 e* Reduction Emissions Fees: when emission fees are based on the socially (good thing) aggregated amounts, the reduction will naturally occur in the most cost effective way 67  Unit 3. Market failure and public intervention Emission Fees: Polluter Problem Advantages of Emission Fees over a Pigouvian tax: (1) The reduction in emissions can come from a reduction in Q new technology pollution filters a change in inputs… Emission Fees will arrive at e* reductions in emissions It does this without necessarily reducing Q (2) When there are multiple “polluters”, it also can also account for different costs of reducing emission across companies. An emissions fee will naturally result in the most cost effective reduction. 68  Unit 3. Market failure and public intervention Public policies to solve externalities (1) Pigouvian Tax a. Pigouvian subsidy (2) Emissions Fees (3) Cap and Trade: Fix an upper limit to total pollution, assign rights to pollute to the firms and to make these rights tradable in a market (4) Command and Control Regulation a. Technology standard b. Performance standard 69 (3) Cap-and-Trade: Polluter Problem Costs and Benefits of pollution reduction P in production of plastics MC to producer of reducing pollution f MSB of pollution reduction 0 e* Reduction (good thing) This is very similar to the idea of emissions fees, only now instead of using pricing, we are using quantity…. 70  Two companies: both creating pollution in production process € € MC2 MC1 f 0= 75 Max=90 pollution 0 25 Max=90 pollution 90 emissions reduction reduction Recall from the emissions fees example that the optimal reduction was 100 units (we want to end up with only 80 units of pollution in society) We saw that the cost effect way to achieve this was company 1 reducing 75 units and company 2 reducing 25 units 71  Two companies: both creating pollution in production process € € Cap-and-trade: MC2 set e*=80 and let companies trade MC1 0= Max=90 pollution 0 Max=90 pollution 90 emissions reduction reduction Claim: at any allocation of permits, we will arrive at the cost effective reduction 72  Two companies: both creating pollution in production process € € Cap-and-trade: b MC2 set e*=80 and let companies trade MC1 a 0= 10 Max=90 pollution 0 Max=90 pollution 90 emissions reduction reduction Claim: at any allocation of permits, we will arrive at the cost effective reduction Assume that company 1 gets all of the permits Company 1 will have to reduce 10 units and can keep polluting 80 units (point a) Company 2 will have to reduce all 90 units of emissions (point b) 73  Two companies: both creating pollution in production process € € Cap-and-trade: b MC2 set e*=80 and let companies trade MC1 a 0= 10 Max=90 pollution 0 Max=90 pollution 90 emissions reduction reduction Assume that company 1 gets all of the permits Result: MC2>MC1 Total costs are much higher than needed to reach the socially desired quantity 74  Two companies: both creating pollution in production process € € Cap-and-trade: b MC2 set e*=80 and let companies trade MC1 a 0= 10 Max=90 pollution 0 Max=90 pollution 90 emissions reduction reduction Trade: Company 1 sells a permit if: The price received for the permit > the MC of reducing pollution 1 more unit (MC1) Company 2 buys a permit if: The price paid for the permit < the savings from polluting one more unit (MC2)75  Two companies: both creating pollution in production process € € Cap-and-trade: b MC2 set e*=80 and let companies trade MC1 a 0= 10 Max=90 pollution 0 Max=90 pollution 90 emissions reduction reduction Trade: ▪ MC1 < P < MC2 76  Two companies: both creating pollution in production process € € Cap-and-trade: MC2 set e*=80 and let companies trade b MC1 a 0= Max=90 pollution 0 Max=90 pollution 90 emissions reduction reduction Trade: ▪ MC1 < P < MC2 ▪ Trade will occur until MC1=MC2, always at pollution=80 (or 100 units reduced) 77  Two companies: both creating pollution in production process € € Cap-and-trade: MC2 set e*=80 and let companies trade MC1 a b 0= Max=90 pollution 0 Max=90 pollution 90 emissions reduction reduction Trade: ▪ MC1 < P < MC2 ▪ Trade will occur until MC1=MC2, always at pollution=80 (or 100 units reduced) 78  Two companies: both creating pollution in production process € € Cap-and-trade: MC2 set e*=80 and let companies trade MC1 a b 0= 75 Max=90 pollution 0 25 Max=90 pollution 90 emissions reduction reduction Trade: ▪ MC1 < P < MC2 ▪ Trade will occur until MC1=MC2, always at pollution=80 (or 100 units reduced) 79  Unit 3. Market failure and public intervention Public polities to solve externalities (1) Pigouvian Tax a. Pigouvian subsidy (2) Emissions Fees (3) Cap and Trade: Fix an upper limit to total pollution, assign rights to pollute to the firms and to make these rights tradable in a market (4) Command and Control Regulation: Force each firm to keep pollution levels below certain threshold a. Technology standard b. Performance standard 80  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Does not use incentive-based regulation (emissions fee and cap-and-trade system) but traditional approaches. Two types: (1) Technology standard (2) Performance standard 81  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Does not use incentive based regulation. Two types: (1) Technology standard Requires a company to install pollution reducing device or under-take a specific pollution-reducing behavior Problem: No room for innovation in better ways Or for the company to pay the cost if it is worth it to them to still pollute (no reallocation of costs) 82  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Does not use incentive based regulation. Two types: (2) Performance standard It sets an emissions goal for each polluter or requirements that are the same for all within a group. Problem: Although this allows for innovation, it does not allow for reallocation of reduction to lower costs. 83  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Does not use incentive based regulation. Two types: (1) Technology standard (2) Performance standard These methods generally reach a rough goal. BUT innately, neither of these methods are likely to be cost effective 84  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Does not use incentive based regulation. Two types: (1) Technology standard (2) Performance standard These methods generally reach a rough goal. BUT innately, neither of these methods are likely to be cost effective Why then ever consider command and control over incentive based? 85  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Why then ever consider command and control over incentive based? 2 reasons: (1) monitoring ease /cost for emissions fees: where to set the fee cap and trade: may not be clear what even to create permits for BUT it is often easy to monitor whether they have installed a device or not 86  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Why then ever consider command and control over incentive based? 2 reasons: (1) monitoring ease /cost for emissions fees: where to set the fee cap and trade: may not be clear what even to create permits for BUT it is often easy to monitor whether they have installed a device or not Therefore, The costs to monitoring incentives can outweigh the cost of using command and control Incentives can be ineffective because of a lack of enforcement possibilities 87  Unit 3. Market failure and public intervention (4) Regulation: Command and Control Why then ever consider command and control over incentive based? 2 reasons: (2) distributional reasons ▪ Incentive-based methods can lead to high concentrations of pollution in certain local areas; because incentive-based methods limit total emissions from all sources, it is possible that some areas will experience higher emissions than others. Localized concentrations of emissions are “hot spots”. However Command and Control restricts emissions from each individual pollution source. ▪Although this would be cost-effective way to achieve an overall pollution level, it definitely hurts some more than others. ▪Technology standard or performance standards will both spread cost on those harmed by the negative externality more evenly. 88  Unit 3. Market failure and public intervention What do we know about externalities? ❖ Externalities arise when the choices of some people affect other people, positively or negatively AND this happens outside regular market mechanisms. ❖ If there is an externality, there is a loss of welfare: production is smaller than the optimal when there is a positive externality and larger when there is a negative externality. ❖ This is innately related to a lack of property rights (why the market fails) ❖ Externalities can be solved with internalization, either by private solutions or by public solutions (taxes, subsidies, regulations, etc.) 89