Problem Set Question 1: Consider The Following Cap And Trade

Problem Setquestion 1consider The Following Cap And Trade Programsa

This problem set focuses on various cap-and-trade programs and their design, effectiveness, and economic implications. It encompasses identifying the targeted pollutants for different programs, analyzing their potential problems such as hot spots, monitoring issues, market thinness, and price volatility. Additionally, it presents a scenario involving water pollution control between a refinery and a paper mill, requiring analysis of marginal costs, benefits, market-based regulation instruments like taxes and cap-and-trade systems, and the distribution of pollution permits.

Paper For Above instruction

Cap-and-trade programs are market-based environmental policies that set a limit on pollution levels and allow entities to buy and sell allowances or permits, providing economic incentives for pollution reduction. These programs aim to efficiently reduce pollution by leveraging market mechanisms, but their design and implementation greatly influence their effectiveness and potential issues.

Identification of Drainage Programs and Their Focus

The list includes various cap-and-trade initiatives: RECLAIM, Bush cap-and-trade proposal, the Regional Greenhouse Gas Initiative (RGGI), Clunker Program, National SO2 Trading, European Trading System (ETS), Bubbles, and Lead trading. Each targets specific pollutants or environmental issues. For instance, RECLAIM and the Bush proposal primarily address urban air pollution and regional smog. RGGI and the European Trading System are designed to combat global warming by reducing greenhouse gases like CO₂. The National SO₂ Trading program was explicitly created to mitigate acid rain, resulting from sulfur dioxide emissions. Mercury pollution is directly targeted by specific mercury trading programs, which are often integrated within broader air quality initiatives or as standalone allowances. Bubbles and lead trading are more flexible permit approaches that can be adapted for various pollutants but are not exclusively designed for specific environmental problems.

Effectiveness and Challenges of Cap-and-Trade Programs

Some programs have encountered challenges such as hot spots—localized areas with high pollution due to uneven permit distribution—monitoring difficulties, enforcement issues, thin markets with limited trading activity, and price volatility. For example, early EPA sulfur dioxide trading faced hot spots where localized pollution remained problematic because of uneven permit allocation or monitoring lapses. Likewise, the European ETS has experienced price swings due to the oversupply of permits and market speculation, impacting economic efficiency.

Water Pollution: Pollution Control Scenario Between a Refinery and a Paper Mill

This case involves the management of water pollution ('gunk') generated by a refinery and a paper mill along the Great Fish River, affecting fish populations and local fishing profits. The cost-benefit analysis considers the costs to clean-up, as well as the benefits to fishers, with the recognition that fishers' profits depend on combined pollution, but individual clean-up costs relate only to each polluter's waste.

a) Marginal Cost Calculation

The marginal cost (MC) to the refinery of cleaning up from 5 to 4 units of pollution is derived from the change in total costs associated with this reduction. If the total and marginal costs are given (or can be deduced) from the table, the MC is the difference in total costs between these two points. The same applies to the mill. If both are at 5 units of pollution, the benefit to fishers of reducing pollution from 5 to 4 is the change in fishers’ profits, which depends on the reduction in total pollution and the resulting improvement in fish habitat.

b) Impact of Pollution Tax

A pollution tax of $3 per ton incentivizes the mill and refinery to reduce emissions. The pollution they choose to emit depends on their marginal costs relative to the tax rate. If a facility's MC of clean-up exceeds $3 at a certain pollution level, it will opt to emit more; if MC falls below $3, it will reduce pollution accordingly.

c) Cap-and-Trade Implementation

Under a cap-and-trade system limiting total pollution to seven units, permits are initially allocated—here, fishers hold permits, which they can sell or hold. With the refinery starting at zero permits, it will be willing to pay up to the marginal benefit of obtaining an additional permit, which corresponds to the reduction in fishers’ damages. Similarly, the mill's willingness to pay hinges on its marginal clean-up costs and the benefit of reducing pollution. The prices at which permits trade are dictated by the equilibrium of these valuations and the marginal costs of pollution reduction.

Beyond initial trades, if permits are sold for less than their marginal valuation by the buyer, and if the sellers’ valuation exceeds the buyer’s willingness to pay, trades will occur until an equilibrium price is achieved. The distribution of permits ultimately reflects the relative marginal costs and benefits, with the final prices influenced by these dynamics.

Conclusion

Tags like hot spots, market thinness, and price volatility highlight practical challenges faced in designing and managing pollution trading systems. Effective regulation must incorporate accurate monitoring, equitable permit allocation, and market stability measures. The case study exemplifies the complexities in applying economic principles to real-world environmental issues, demonstrating the importance of integrating cost-benefit considerations with market-based approaches in pollution control strategies.

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