Negative Externalities - PowerPoint by gabyion

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									Negative Externalities

           David Levinson
• To measure externalities as a function
  of usage
• To enable the evaluation of the “Full
  Cost” of different modes under different
• To measure the costs consistently (in
  $/pkt) to compare fairly
•   What are externalities
•   Key Issues
•   Our approach to the problem
•   Cost by cost discussion
•   Summary
 Private Cost vs. Social
• The purpose of                   • The difference between
  distinguishing private and         private and social cost is that
  social cost is to correct for      in making a decision a
  real resource misallocation        private individual will take
  from economic agents               account of the costs they
  actions which impose a cost        face but will not consider the
  (or benefit) on others in the      impact of their decision on
  market. The market provides        others which may, in fact.
  no incentive for agents to         impose a cost upon them. If
  take account of their actions.     this occurs an externality will
                                     misallocate resources since
                                     the economic agents is not
                                     forced to pay the cost they
                                     impose or does not receive
                                     any compensation for the
                                     benefits which they confer.
•   An externality is that situation in   • Examples:
    which the actions of one agent
    imposes a benefit or cost on            – negative externalities
    another economic agent who is             (external disbenefits) are
    not party to a transaction.               air pollution, water
•   Externalities are the difference          pollution, noise,
    between what parties to a
    transaction pay and what                  congestion.
    society pays                            – positive externalities
•   A pecuniary externality,                  (external benefits) are
    increases the price of a                  bees from apiary
    resource and therefore involves
    only transfers,                           pollinating fruit trees and
•   A technical externality exhibits a        orchards supplying bees
    real resource effect. A technical         with nectar for honey.
    externality can be an external
    benefit (positive) or an external
    disbenefit (negative).
 Source of the Problem
• The source of externalities is   • We want that amount of the
  the poorly defined property        externality which is only
  rights for an asset which is       worth what it costs.
  scarce. For example, no one        Efficiency requires that we
                                     set the price of any asset >0
  owns the environment and           so the externality is
  yet everyone does. Since no        internalized. If the price is
  one has property rights to it,     set equal to the marginal
  no one will use it efficiently     social damages, we will get
  and price it. Without prices       a socially efficient amount of
  people treat it as a free good     the good or bad. Economic
  and do not cost it in their        agents will voluntarily abate
  decision making. Overfishing       if the price is non-zero.
  can be explained in the
  same way.
        Coase Theorem
• The Coase Theorem states that in the
  absence of transaction costs, all
  allocations of property are equally
  efficient, because interested parties will
  bargain privately to correct any
  externality. As a corollary, the theorem
  also implies that in the presence of
  transaction costs, government may
  minimize inefficiency by allocating
  property initially to the party assigning it
  the greatest utility.
     Pareto Optimality
• A change that can make at least one
  individual better off, without making any
  other individual worse off is called a
  Pareto improvement: an allocation of
  resources is Pareto efficient when no
  further Pareto improvements can be
 What is the Optimal
Amount of Externality
• 0?
• Why / Why Not? [____]
   Full Cost (FC) Model
• FC = (CUT - TU) + CI + CE + CN + CA + CT
   – User Costs (CU),
        • Total costs borne by users (CUT).
            – cost of vehicle ownership (as measured by depreciation)
            – the cost of operating and maintaining the vehicle (including gas, tires,
               repairs and such).
        • User Transfers (TU) = (infrastructure, accident and safety)
   –   Infrastructure Costs (CI),
   –   Environmental Costs (CE),
   –   Noise Costs (CN),
   –   Accident and Safety Costs (CA), and
   –   Time Costs (CT).
            Key Issues
• “Externalities” are Inputs to Production
  System. Clean Air, Quiet, Safety,
  Freeflow Time are used to produce a
• The System has boundaries: Direct
  effects vs. Indirect effects
• Double Counting must be avoided
         Selection of
• Criteria: Direct Effects
• Not Internalized in Capital or Operating
• External to User (not necessarily to
• Result: Noise, Air Pollution, Congestion,
• Not: Water Pollution, Parking, Defense
Highway                    Noise

                           Air Pollution


     Noise: Measurement
•   Noise: Unwanted Sound
•   dB(A) = 10 log (P2/Pref)
•   P: Pressure, Pref: queitest audible sound
•   NEF: Noise Exposure Forecast is a
    function of number (frequency) of
    events and their loudness.
     Noise: Generation
• Amount of noise generated is a function
  of traffic flow, speed, types of traffic.
• Additional vehicles have non-linear
  effect: e.g. 1 truck = 80 db, 2 trucks =
  83 db, but sensitivity to loudness also
• Noise decays with distance
      Noise: Valuation
• Hedonic Models: Decline of Property
  Values with Increase in Noise --> Noise
  Depreciation Index (NDI).
• Average NDI from many highway and
  airport studies is 0.62. For each unit
  increase in dB(A), there is a 0.62%
  decline in the price of a house
     Noise: Integration
• Noise Cost Functions ($/pkt) : f(Quantity
  of Noise, House Values, Housing
  Density, Interest Rates)
• Using “reasonable” assumption, this
  ranges from $0.0001/vkt - $0.0060/vkt
  for highway. Best guess = $0.0045/pkt.
• For air, about the same, $0.0043/pkt.
        Air Pollution:
• Air Pollution Problems: Smog, Acid
  Rain, Ozone Depletion, Global Climate
• EPA “Criteria” Pollutants: HC (a.k.a.
  VOC, ROG), NOx, CO, SOx, PM10
• Other Pollutants: CO2
           Air Pollution
• Comparison of Modes
    Mode         Pax km HC kg,              CO      NOx C,Ton
                            M             kg,M    kg, M    M
                               (gm/pkt) (gm/pkt) (gm/pkt) (gm/pkt)
    Highways    5.4 x10          5,118 32,690       5,945   263.2
                                (0.95) (6.053)     (1.11)    (46)
    Jets        5.8 x1011           54     163       72.7    59.2
                               (0.093) (0.28)      (0.13)   (100)
    Total                        6,409 39,972       7,918
    Total All                  18,536   60,863    19,890
        Air Pollution:
• Local Health Effects, Material and
  Vegetation Effects, Global Effects
• Greatest Uncertainty in Global Effects,
  Proposed “Carbon Tax” have 2 orders
  of magnitude differences
      Air Pollution:
Pollutant Air Cost Highway Costs
         ($/pkt)      ($/vkt)
PM10     ---          $0.000085

SOx      ---          $0.000315

HC       $0.0001530   $0.003850

CO       $0.0000018   $0.000049

NOx      $0.0001700   $0.001000

Carbon   $0.0005800   $0.000260

TOTAL    $0.0009048   $0.005559
• Time: Congested, Uncongested
• Congested Time Increases as Flow
  Approaches, Exceeds “Capacity”
• Uncongested Time: Freeflow Time +
  Schedule Delay
• Air Transportation: Delay vs. Usage
 Congestion: Valuation
• Value of Time is a function of mode,
  time of day, purpose, quality of service,
• Wide range, typically $50/hr air, $30/hr
  car. (Business Trips more valuble than
  Personal Trips).
• On other hand, average hourly PCI rate
  (40 hour week) gives $10/hr
• Time Cost Functions:
TC = VoT Qh ( Lf/ Vf + a (Qh / Qho)b)
• highway: a=0.32, b=10
• air: a=2.33, b=6
• Number of Accidents by Severity
• Multiple Databases (NASS, FARS)
• Multiple Agencies (NHTSA, NTSB), +
  states and insurance agencies
• Inconsistent Classification
• Non-reporting
 Accidents: Generation
• Accident Rates, Functions
• Highway: Accident Rate = f(urban/rural,
  onramps, auxiliarly lanes, flow,
• Air: Accident Rate = f( type of aircraft)
    Accidents: Valuation
•   Value of Life:
•   average of studies $2.9 M
•   average of highway studies $2.7 M
•   Cost of Non-fatal accident depends on
    property damage, injury (degree of
    functional life lost, police costs, etc.)
Accidents: Integration
• Highway Accident Costs estimates
  range from $0.002 - $0.09/pkt. Our
  estimate is $0.02/pkt.
• Urban / rural tradeoff. Urban more but
  less severe accidents.
• Air Accident Costs $0.0005/pkt.
        Summary: $/pkt
Cost Category Air System Highway System
Noise           $0.0043   $0.0045
Air Pollution   $0.0009   $0.0037
Accidents       $0.0005   $0.0200
Congestion      $0.0017   $0.0046
TOTAL           $0.0073   $0.0328
 Summary: Conceptual
• High Uncertainty About Valuation
• Costs Vary with Usage
• Accounting, Difficult, but necessary to
  avoid double counting.
• To establish optimal
  emission level s for pollution,
  congestion or any other
  externality consider the             i
                                      TCA = c i(A i ) = c i(Z i – e i )     (2)
  following framework.
                                      is the cost of abatementwith
• Let ei = total emission from
  source i.                           c 'A > 0 and cA  0

• Let Zi = amount of emission         and
  at source i in an uncontrolled      TD = f(e)                           (3)
                                      is the damage function at receptorpoints
• Let Ai = Zi - ei be the
  abatement at source i. (1)
• Note if Ai = 0, Zi = ei or actual
  emissions equal the
  maximum amount possible.
• The solution to the problem, if we consider
  two sources of pollution, is to minimize the
  sum of damage costs and abatement costs or
 min f(e 1 + e2) + c1 (Z 1 – e1 ) + c 2 (Z2 – e2)                (4)
 df = dc 1 = dc 2 = c which indicates a constant marginal damage function
 de dA 1 dA 2
           Optimal Amount
• The following is true:          • This states that the
                                    optimal amount of any
                                    externality is
   TCiA = c i (Z i – e i) i=1,2     established by
   dc i dc i  A i
                                    minimizing the sum of
       =                           damage and abatement
   de i dA i ei
                                    costs so we end up with
    – dci = dc i                   E* amount of aggregate
       dei dA i
                                    pollution distributed
                                    among the various
                                    sources as illustrated.
       Internalizing the
• If a profit maximizing firm were faced with an
  abatement charge they would internalize the
  externality or abate until the mc of abatement
  were equal to the price of pollution or the
  change; that is,

  i = R(Q) – c(Q) c'(A i) –cei

        c i
   set      =c
        A i
Government Standards
•    If the government wanted to establish a 'standard' it
    would be . To determine these standards would
    require knowledge of:
    – level of marginal damages
    – mc function of polluters
• It would therefore appear that there is an
  informational advantage to pricing.
• The solution which has been illustrated above also
  applies with:
• 1. spatially differentiated damages
• 2. non-linear damage functions
• 3. non-competitive market settings
     Why Standards
    Dominate Charges
• (A) Uncertainty with respect to the
  marginal damage function.
• (B) Uncertainty with respect to the
  marginal abatement costs.
 Uncertainty with respect
  to the marginal damage
• Now consider the situation
 where the MC of abatement has
 been underestimated so the
 true MC of abatement lies
 above the estimated MC of
 abatement function. Consider a
 standards scheme. Using the
 estimated MC of abatement the
 emission level is set at e instead
 of e*. Thus, the emission level is
 too low relative to the optimum.
 With the level of abatement too      Alternatively, suppose the authority set a sub-
 high, the damages reduced due        optimal emission standard of e because it is using
 to having this lower level of        the erroneous MD function. With emissions at e
 emissions is eAce* but at the        rather than e*, we again end up with a net social
 cost of much higher abatement        loss of ABC. Therefore, uncertainty with respect
 costs of eBCe*. The net social       to the marginal damage function provides NO
                                      ADVANTAGE to either scheme; pricing or
 loss will be ABC.                    standards.
 Uncertain with respect
 to marginal abatement
• Now consider the situation
 where the MC of abatement has
 been underestimated so the
 true MC of abatement lies
 above the estimated MC of
 abatement function. Consider a
 standards scheme. Using the
 estimated MC of abatement the
 emission level is set at e instead
 of e*. Thus, the emission level is
 too low relative to the optimum.
 With the level of abatement too
 high, the damages reduced due
 to having this lower level of
 emissions is eAce* but at the
 cost of much higher abatement
 costs of eBCe*. The net social
 loss will be ABC
    Abatement: Pricing v.
•    Now consider a pricing scheme.        WL T = WL q = – 1 EC • e
                                                                        2    1   1
                                                                             D +  c
                                                           2 e
    The authority would set the
                                           w here
    emission charge at EC by setting
    the MD function equal to the MC of     WL T is the w elfare loss from pricing
    abatement function. This would         WL q w elfareloss from standards
    result in a level of emission of e;    e is e'–e
    thinking this is the correct amount.    D is the elasticity of the marginal damage function
    But with a true MC of abatement at     c is the elasticity of the marginal cost of abatement function
    MCT the level of emissions which
    the charge EC will generate will be     The welfare loss from pricing and
    e'.                                     standards will be equal if
•   e' > e* so we have too high a level     1. = in absolute value
    of emissions. Pollution damages will    or
    increase by the amount e*CDe' but       2. ∆e = 0 or MCA = MCT
    the abatement costs will be reduced
    (because of higher allowed
    emissions) by e*CEe'. Therefore,        Standards will be preferred to charges
    the net social loss will be CDE.        when WLT - WLq > 0, which occurs when
•   Generally, there is no reason to        |eD| < |eC|. If |eC| 0 charges are
    expect CDE = ABC but it has been        preferred while if || 0 standards are
    shown that                              preferred.
• The rationale for this is:

• (a) if the MD function is steep (e.g. with very toxic pollution)
  even a slight error in e will generate large damages. With
  uncertainty about costs, the chances of such errors is greater
  with a charging scheme.
• (b) if the MD function is flat, a charge will better approximate
  marginal damages. If the damage function is linear, the optimal
  result is independent of any knowledge about costs.
• (c) if the MC is steep, an ambitious standard could result in
  excessive costs to abators. A charge places an upper limit on
• Therefore, the KEY in this is charges set an upper limit on costs
  while standards set an upper limit on discharges.
            Externalities in
• Transportation sources in North America contribute

•       47% of NOx
•       71% of CO
•       39% of HC

• To control most pollutants we have opted for standards rather
  than pricing. This is reflected in the 'level of allowed emissions'
  with catalytic converters on our vehicles.

• Noise is another example where the U.S. has opted for a
  technological fix to achieve a standard. Europeans have,
  however, introduced noise charges at some airports for aircraft
  which exceed a particular noise level.
       External Prices
• Externality prices can take three forms:
• 1. use to optimize social surplus
• 2. use to achieve a predetermined standard
  at least cost]
• 3. use to induce compliance to a particular
• Perhaps the best know 'cure' for the
  congestion externality facing most major
  cities has been advocated by economists;
  road pricing. Standards are achieved in this
  instance by continuing to build roads.

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