Optimal Abatement Level Research Articles

Economics of social trade-off: Balancing wastewater treatment cost and ecosystem damage

We have developed a social optimization model that integrates the financial and ecological costs associated with wastewater treatment and ecosystem damage. The social optimal abatement level of water pollution is determined by finding the trade-off between the cost of pollution control and its resulting ecosystem damage. The model is applied to data from the Lake Taihu region in China to demonstrate this trade-off. A wastewater treatment cost function is estimated with a sizable sample from China, and an ecological damage cost function is estimated following an ecosystem service valuation framework. Results show that the wastewater treatment cost function has economies of scale in facility capacity, and diseconomies in pollutant removal efficiency. Results also show that a low value of the ecosystem service will lead to serious ecological damage. One important policy implication is that the assimilative capacity of the lake should be enhanced by forbidding over extraction of water from the lake. It is also suggested that more work should be done to improve the accuracy of the economic valuation.

Price Effects, Inefficient Environmental Policy, and Windfall Profits

We examine conditions under which a new or tighter restriction on emissions from a competitive polluting industry creates price effects in adjacent markets. Price effects may arise when a quantity restriction on emissions causes output to fall and, therefore, output price to rise. They may also arise when the required reduction in output causes the price of a polluting input to fall. We model emissions as a fixed proportion of output, limiting the possibilities for input substitutions. The possibility of price effects exists whenever the set of regulated firms is large relative to its input or output markets, a possibility that is expressly ruled out in Montgomery’s (J Econ Theory 5:395–418, 1972) paper. Two potential implications of price effects are explored. One is an efficiency concern: a welfare-maximizing regulator who neglects price effects will require more than the optimal level of abatement. The other is a distributional concern: an emissions restriction might create windfall profits for the polluting industry.

Emissions abatement R&D: Dynamic competition in supply schedules

This paper investigates the optimal environmental policy (the mix of emissions tax and research and development [R&D] subsidy) in a dynamic setting when two firms, producing differentiated products, compete in the output market over time. Firms compete in a differential game setting over supply schedules, which encompasses a continuum of imperfect competition equilibria from Bertrand to Cournot. Although production generates environmentally damaging emissions, firms can undertake R&D that has the sole purpose of reducing emissions. In addition to characterizing the optimal policy, we examine how the optimal tax and subsidy, and the optimal level of abatement, change as competition intensifies, as the dynamic parameters change, and as the investment in abatement technology changes. In this setting, competition increases welfare through its impact on the final goods price. However, lower prices result in larger quantities and more pollution. Our key contribution is to show how the impact of increased competition on welfare depends on the extent of the market and the nature of preferences and technology.

Supply chain coordination with green technology under cap-and-trade regulation

Cap-and-trade regulation is generally accepted as one of the most effective market-based mechanisms to curb carbon emissions. In this paper, we study the production and emission abatement decisions of a Make-To-Order supply chain consisting of a manufacturer and a retailer under cap-and trade regulation. Specifically, the manufacturer can reduce unit product carbon emission by using green technology, with the cooperation of a retailer by certain contracts, who sell the products to environment-concerned consumers. Wholesale price and cost sharing contracts are considered in the supply chain. We list some main conclusions here. First, as carbon trading price increases, the optimal production quantities (the optimal abatement levels) firstly decrease (increase) and then remain constant. Second, both wholesale price and cost sharing contracts can coordinate the supply chain. Last, combining the optimal operational decisions under the two contracts with two-part tariff agreement, we design a contract in which the retailer pays a lump fee to the manufacturer, and find that there is an interval of the lump fee to achieve Pareto improvement for the two firms.

Challenges in Quantifying Optimal CO2 Emissions Policy: The Case of Electricity Generation in Florida

The U.S. Environmental Protection Agency released a proposed rule to limit carbon dioxide emissions from power plants on June 2, 2014. Implementing public policy without understanding its economic impacts can be costly and unproductive. This problem is paramount when a price of carbon dioxide (CO2) emissions is considered as a vehicle for abatement. Many studies have attempted to quantify the economic significance of such actions. These studies focus on levels of variables such as the amount of CO2 emissions, the cost of emissions allowances, and the broad impact of increased electricity prices, rather than on the marginal effects of policy change. This paper addresses this deficiency by utilizing a model that simulates the dispatch of electric generating units in the state of Florida and demonstrates that the incremental cost of abatement curves may fluctuate and may not be well-behaved, and that this complicates identifying an ‘optimal’ level of abatement and how it may be achieved. Agreement on the marginal costs and marginal benefits of CO2 abatement can be seen as a necessary condition for the determination of an optimal level of abatement, but not a sufficient one.

Environmental Policy Implications of Extreme Variations in Pollutant Stock Levels and Socioeconomic Costs

Motivated by recent evidence on the possibility of jumps in carbon dioxide emission levels and abrupt increases in pollutant-related socio-economic costs, this paper uses a real options approach to examine their impact with respect to the optimal timing of environmental policies and the optimal emissions abatement level. To this end, we extend the methodology of Pindyck (2000) using jump diffusion processes. We show that if pollutant stock levels are subject to extreme variations and the emissions abatement level is chosen exogenously by the policymaker, then environmental policy measures should be taken earlier. A similar, yet more prominent, effect is observed under the assumption that pollutant-related socio-economic costs and benefits are expected to exhibit abrupt changes. However, different results are obtained when we examine simultaneously the two interrelated decisions, namely, the optimal timing of emissions abatement and the optimal abatement level. In this case, an increase in the size and/or probability of a jump, delays policy adoption but leads to higher optimal abatement.

Environmental policy implications of extreme variations in pollutant stock levels and socioeconomic costs

This paper uses a real options approach to examine the impact of abrupt increases in carbon dioxide emissions and pollutant-related socio-economic costs. It derives optimal investment rules in the form of critical values for both pollutant stock levels and social costs, above which environmental policies should be adopted. Moreover, it determines the optimal emissions abatement level. Our analysis extends the methodology of Pindyck (2000) using jump diffusion processes. We show that if the stock of pollutant is subject to extreme variations and the emissions abatement level is chosen exogenously by the policymaker, then lower levels of the pollutant stock are required to trigger policy adoption. A similar, yet more prominent, effect is observed under the assumption that pollutant-related socio-economic costs and benefits are expected to exhibit abrupt changes. However, different results are obtained when we examine simultaneously the two interrelated decisions, namely, the optimal threshold of emissions abatement and the optimal abatement level. In this case, an increase in the size and/or probability of a jump increases the critical values of both pollutant stock levels and socio-economic costs but leads to higher optimal abatement.

Regulation with anticipated learning about environmental damages

A regulator anticipates learning about the relation between environmental stocks and economic damages. For a model with linear-quadratic abatement costs and environmental damages, and a general learning process, we show analytically that anticipated learning decreases the optimal level of abatement at a given information set. If learning causes the regulator to eventually decide that damages are higher than previously thought, learning eventually increases abatement. Learning also favors the use of taxes rather than quotas. Using a model that is calibrated to describe the problem of global warming, we show numerically that anticipated learning causes a significant reduction in first period abatement and a small increase in the preference for taxes rather than quotas. Even if the regulator's initial priors about environmental damages are much too optimistic, he is able to learn quickly enough to keep the expected stock trajectory near the optimal trajectory.

Essays on Uncertainty and Decision-Making in Environmental Economics

This draft PhD thesis analyzes four issues in the research field that consists of the intersection of environmental economics, uncertainty, and decision-making. 1. Economic investments that lead to environmental damages beyond repair - like cutting rainforests or emitting pollutants with long life times - can be interpreted as irreversible investments with uncertain pay-offs. In the context of irreversible investments under uncertainty two different concepts of option value were developed. They account for the value of keeping options open - i.e. postponing the irreversible investment - in the presence of potential future learning about the social profitability of the investment. These are the concept of quasi-option value (value of information) developed in the environmental and resource economic literature and the concept of real option value (value of the option to postpone) developed in the financial economics literature. This thesis shows that the quasi-option value (value of information) is that part of the real option value (value of the option to postpone) that is related to uncertainty being resolved over time. This means that common knowledge in the environmental and resource economic literature with respect to the relation of both concepts is not correct. 2. If marginal damages of pollution rise with the pollution level, low marginal pollution abatement costs demand a relatively low Pigouvian tax - the pollution tax level that leads to optimal abatement. As a result, to determine the Pigouvian tax level, a regulator needs to know pollution abatement costs, information that is privately owned by individual pollutors. Unfortunately, pollutors have no intention to reveal their true abatement costs. One text book solution to this problem is that the regulator keeps adapting the tax level until the pollution tax leads to an emission level resulting in marginal damages equal to the tax level - the criterium for social optimality. That is, only after an unspecified amount of time and abatement adaptation costs the socially optimal abatement level is reached. This thesis shows there exists a non-linear tax system, the so called differential tax that triggers firms to reveal their abatement costs truthfully and will lead to socially optimal abatement levels instantly, thereby reducing social costs compared to the iterative solution. 3. In the presence of environmental innovation, future abatement costs are unknown by the polluting firms as well. Under those circumstances the regulator is needs a tax system that is flexible with respect to falling abatement costs through innovation (please recall that lower marginal abatement costs demand a lower Pigouvian tax) as well as keeps incentives for innovation - created by pollution taxes after innovation - upright. This thesis analyzes the effects of a robust second-best pollution taxation scheme that combines flexibility to cope with changing marginal abatement costs with commitment to relatively high tax levels to create incentives for environmental innovation. It shows that this instrument is superior to time consistent taxation. Superiority of the flexible taxation scheme with respect to commitment to a linear tax could not be shown. 4. The use of quantitative model results to support policy making is one way social sciences might have a positive effect on real world decision making. This thesis identifies decision-maker related potential errors made in the interpretation of quantitative model results. It is argued these errors can be prevented by the social scientist by stating explicitly for which policy maker and for what purpose the model results are meant for.

Regulation with Anticipated Learning about Environmental Damages

A regulator anticipates learning about the relation between environmental stocks and economic damages. For a model with linear-quadratic costs and a general learning process, we show analytically that anticipated learning decreases the optimal level of abatement at a given information set. If learning causes the regulator to eventually decide that damages are higher than previously thought, learning eventually increases abatement. Learning also favors the use of taxes rather than quotas. Using a model that is calibrated to describe the problem of global warming, we show numerically that anticipated learning causes a significant reduction in first period abatement and a small increase in the preference for taxes rather than quotas. Even if the regulator's initial priors about environmental damages are much too optimistic, he is able to learn quickly enough to keep the expected stock trajectory near the optimal trajectory.

How Large are the Welfare Gains from Technological Innovation Induced by Environmental Policies

This paper examines whether the welfare gains from technological innovation that reduces future abatement costs are larger or smaller than the “Pigouvian” welfare gains from optimal pollution control. The relative welfare gains from innovation depend on three key factors—the initially optimal level of abatement, the speed at which innovation reduces future abatement costs, and the discount rate. We calculate the welfare gains from innovation under a variety of different scenarios. Mostly they are less than the Pigouvian welfare gains. To be greater, innovation must reduce abatement costs substantially and quickly and the initially optimal abatement level must be fairly modest.

Compulsory environmental liability insurance as a means of dealing with climate change risk

Conventional economic instruments encourage least cost emissions abatement but provide no information about the optimal level of abatement. A mechanism is suggested that involves markets in communicating both the potential costs of climate change and the risks of incurring these costs, so that the externality is properly priced. The suggested mechanism involves placing liability for consequences of climate change with emitters and obliging them to insure against these consequences, with the government acting as insurer of last resort.

Joint Management of Emission Abatement and Technological Innovation for Stock Externalities

We investigate how emission abatement and technological innovation provide different solutions to reduce pollutant emissions. In the case of a stock externality emission abatement leads to a smooth and continuous adjustment of emissions. Conversely, technological innovation has to be interpreted as an option on a less polluted environment and can justify the use of a pollution threshold above which it is optimal to start a research and development programme for a less polluting technology. It is shown that technological innovation interferes with the traditional emission abatement approach. The optimal abatement level is logically lowered once the less polluting technology is available; nevertheless a temporary increase in emissions is optimal during the research and development period. The usual Pigouvian tax system proves to remain an efficient corrective instrument. A numerical application to the Greenhouse effect is provided.

Decision making under uncertainty and inertia constraints: sectoral implications of the when flexibility

Current debates on climate mitigation emphasize the role of the inertia of the economic system. Our aim in this paper is to study in more depth how sectorally differentiated inertia impacts on optimal CO 2-emission abatement policies. Using the STARTS model, we show that optimal abatement levels and costs differ sensibly among sectors. Differential inertia is the critical determinant of this trade-off, especially in the case of a 20-year delay in the action, or in an underestimation of the growth of the transportation sector. In particular, the burden of any additional abatement effort falls on the most flexible sector, i.e. the industry. Debates on mitigation emphasize the role of inertia of the economic system. This paper aims at studying more in depth how sectorally differentiated inertia should influence optimal CO 2 emission abatement policies. Using a two-sector version of STARTS, we show that under perfect expectations, optimal abatement profiles and associated costs differ sensibly between a flexible and a rigid sector (transportation). In a second step, we scrutinize the role of the uncertainty by testing the case of a 20-year delay of action and an underestimated growth of the transportation sector. We do this for three concentration ceilings and we point out the magnitude of the burden which falls on the flexible sector. We derive some policy implications for the ranking of public policies and for incentive instruments to be set up at international level.