Sulfur Dioxide Emissions

In 1968 Philadelphia imposed air quality regulations that limited the maximum allowable sulfur content in fuel oil to 1.0 percent or less. This regulation decreased sulfur dioxide levels in the air substantially-from 0.10 parts per million in 1968 to below0.025 parts per million in 1973. This improved air quality led to better human health, less damage to materials, and higher property values. But these improvements had a cost: Industrial, manufacturing, commercial, and residential fuel users had to alter their fuel choices and to install pollution-control equipment to abate the pollution. Was the benefit-the reduction in social cost due to the abatement-worth the additional abatement cost? A cost-benefit study of reductions in sulfur dioxide emissions provides some answers.

In Philadelphia the emissions reductions necessitated increased costs of converting from coal and oil to gas to comply with the air quality regulation. Emissions control equipment also had to be added to manufacturing processes to ensure that fuels were used efficiently. Figure 18.7 shows the marginal social cost and the marginal cost to the firm of reduced emissions. Note that the marginal abatement cost jumps whenever new capital-intensive pollution control equipment is needed to improve fuel efficiency

The benefits of reduced sulfur dioxide emissions can he divided into three parts: (1) reductions in illness and death from diseases like cancer, bronchitis, pneumonia, emphysema, asthma, and the common cold; (2) reductions in materials costs caused by corrosion of metals, stone, and paint; and (3) improvements in visibility and other aesthetic values.

Because benefits are the negative of social costs, we can obtain information about the marginal social cost curve by asking how each of these three

With limited information and costly monitoring, a marketable permit system is not always ideal. For example, if the total number of permits is chosen incorrectly and the marginal cost of abatement rises sharply for some firms, a permit system could drive those firms out of business by imposing high abatement costs. (This would also be a problem for fees.) For further discussion of fees, standards, and transferable pollution permits, see William J. Baumol and Wallace E. Oates, Economics, Environmental Policy, and the Quality of Life (Englewood Cliffs, N.J.: Prentice-Hall, 1979).

The study is by Thomas R. Irvin, "A Cost-Benefit Analysis of Sulfur Dioxide Abatement Regulations in Philadelphia," Business Economics (Sept. 1977): 12-20.

Sulfur Dioxide Concentration (ppm)

FIGURE 18.7 Sulfur Dioxide Emissions Reductions. The efficient sulfur dioxide concentration equates the marginal abatement cost to the marginal social cost. Here the marginal abatement cost curve is a series of steps, each representing the use of a different abatement technology.

types of benefits decreases in value when sulfur dioxide concentrations are increased. For very low concentrations, evidence suggests little health, material, or aesthetic effects. But for moderate concentrations of sulfur dioxide, studies of respiratory diseases, corrosion of materials, and lost visibility suggest that marginal social costs are positive and relatively constant. Thus, the marginal social cost curve is shown to rise initially and then become horizontal.

The efficient level of reduced sulfur dioxide emissions is given by the number of parts per million of sulfur dioxide at which the marginal cost of reduced emissions is equal to the marginal social cost. We can see from Figure 18.7 that this level is approximately 0.0275 parts per million. The marginal social cost and marginal abatement cost curves intersect at a point where the marginal abatement cost curve is sharply decreasing owing to the introduction of expensive desulfurization equipment. Because 0.0275 parts per million is slightly below the emissions level achieved in 1973 by the regulation, we can conclude that the regulation improved economic efficiency. In fact, given that sulfur dioxide levels were above 0.0275 parts per million for most of the period, it appears that the regulations were not stringent enough to achieve the most efficient outcome.

The cost of air pollution control during the 1980s was approximately $18 billion per year.4 An effective emissions trading system could reduce those costs substantially in the decades to come. The Environmental Protection Agency's "bubble" and "offset" programs provided a modest attempt to use a trading system to lower cleanup costs. A bubble allows an individual firm to adjust its pollution controls for individual sources of pollutants, as long as a total pollutant limit for the firm is not exceeded.

In theory a bubble could be used to set pollutant limits for many firms or for an entire geographic region; in practice, however, it has been applied to individual firms. The result is, in effect, that "permits" are traded within the firm-if one part of the firm could reduce its emissions, another part of the firm would be allowed to emit more. Abatement cost savings associated with the EPA's program of 42 bubbles have been approximately $300 million since 1979.

Under the offset program, new sources of emissions may be located in regions in which air quality standards have not been met, but only if they offset their new emissions by reducing emissions from existing sources at least as much. Offsets can be obtained by internal trading, but external trading among firms is also allowed. Over 2,000 offset transactions have occurred since 1976.

Because of their limited natures, the bubble and offset programs substantially understate the potential gain from a broad-based emissions trading program. In one study, the cost of achieving an 85 percent reduction in hydrocarbon emissions in all of the DuPont plants in the United States was estimated under three alternative policies: (i) each source at each plant must reduce emissions by 85 percent; (ii) each plant must reduce its overall emissions by 85 percent; only internal trading is possible; and (iii) total emissions at all plants must be reduced by 85 percent, and both internal and external trading are possible. When no trading was allowed, the cost of emissions reduction was $105.7 million. Internal trading reduced the cost to $42.6 million. Allowing for both external and internal trading reduced the cost further to $14.6 million.

Clearly, the potential cost savings from an effective transferable emissions program can be substantial. This may explain why Congress focused on transferable permits as a way of dealing with "acid rain" in the 1990 Clean Air Act. Acid rain is created when sulfur dioxide and nitrogen oxide pollution travels through the atmosphere and returns to earth as sulfuric and nitric acids. These acids can be extremely harmful to people, animals, vegetation, and buildings. The government has authorized a permit system to reduce sulfur dioxide emissions by 10 million tons and nitrogen oxide emissions by 2.5 million tons by the year 2000;

See Robert W. Hahn and Gordon L. Hester, "The Market for Bads: EPA's Experience with Emissions

Trading,"Regulation (1987): 48-53.

5 M.T Maloney and Bruce Yandle, "Bubbles and Efficiency: Cleaner Air at Lower Cost," Regulation

Under the plan, each tradeable permit will allow a maximum of one ton of sulfur dioxide to be released into the air. Stations will be allocated permits in proportion to their current level of emissions. In the next decade the oper-ability of the permit system will be tested; a major obstacle is the array of state public utility regulatory policies that could limit the ability of the market for permits to work.

Recycling

To the extent that the disposal of waste products involves no cost to either consumers or producers, society will dispose of too much waste material. The overutilization of virgin materials and the underutilization of recycled materials will result in a market failure that may require government intervention. Fortunately, given the appropriate incentive to recycle products, this market failure can be corrected.6

To see how recycling incentives can work, consider a typical household's decision with respect to the disposal of glass containers. In many communities, households are charged a fixed annual fee for trash disposal. As a result, these households can dispose of glass and other garbage at very low cost-only the time and effort to put the materials in a trash receptacle.

The low cost of disposal creates a divergence between the private and the social cost of disposal. The marginal private cost of disposal, which is the cost to the household of throwing out the glass, is likely to be constant (independent of the amount of disposal) for low to moderate levels of disposal, and then to increase for large disposal levels involving additional shipping and dump charges. In contrast, the social cost of disposal includes the harm to the environment from littering as well as the injuries caused by sharp glass objects. Marginal social cost is likely to increase, in part because the marginal private cost is increasing, and in part because the environmental and aesthetic costs of littering are likely to increase sharply as the level of disposal increases.

Both cost curves are shown in Figure 18.8. In the figure, the horizontal axis measures, from left to right, the amount of scrap material m that the household disposes, up to a maximum of 12 pounds per week. Consequently, the amount recycled can be read from right to left. As the amount of scrap disposal increases, the marginal private cost, MC, increases, but at a much lower rate than the marginal social cost MSC.

Recycling of containers can be accomplished by a municipality or a private firm that arranges for collection, consolidation, and processing of materials. The marginal cost of recycling is likely to increase as the amount of recycling

Even without market intervention, some recycling will occur if the price of virgin material is sufficiently high. For example, recall from Chapter 2 that when the price of copper is high, there is more recycling of scrap copper.

Scrap

FIGURE 18.8 The Efficient Amount of Recycling. The efficient amount of recycling of scrap material is the amount that equates the marginal social cost of scrap disposal, MSC, to the marginal cost of recycling, MCR. The efficient amount of scrap for disposal m* is less than the amount that will arise in a private market, mi.

grows, in part because collection, separation, and cleaning costs grow at an increasing rate. The marginal cost of recycling curve, MCR, in Figure 18.8 is best read from right to left Thus, when there is 12 pounds of disposed material, there is no recycling and the marginal cost is zero. As the amount of disposal decreases, the amount of recycling increases, and the marginal cost of recycling increases.

The efficient amount of recycling occurs at the point at which the marginal cost of recycling, MCR, is equal to the marginal social cost of disposal, MSC. As Figure 18.8 shows, the efficient amount of scrap for disposal m* is less than the amount that will arise in a private market, mi.

Why not utilize a disposal fee, a disposal standard, or even transferable disposal permits to resolve this externality? Any of these policies can help in theory, but they are not easy to put into practice, and are rarely used. For example, a disposal fee is difficult to implement because it would be very costly for a community to sort through trash to separate and then to collect glass materials. Pricing and billing for the scrap disposal would also be expensive, since the weight and composition of materials would affect the social cost of the scrap and, therefore, the appropriate price to be charged.

One policy solution that has been used with some success to encourage recycling is the refundable deposit1 Under a refundable deposit system an initial deposit is paid to the store owner when the glass container product is purchased. The deposit is refunded if and when the container is returned to the

See Tom Tietenberg, Environmental and Natural Resource Economics (Chicago: Scott, Foresman, and Company, 1988), Chapter 8 for a general discussion of recycling, and Richard Porter, "A Social Benefit-Cost Analysis of Mandatory Deposits on Beverage Containers,"Journal of Environmental Economics and Management (1978): 351-366, for an analysis of mandatory deposit systems.

store or to a recycling center. Refundable deposits create a desirable incentive: the per-unit refund can be chosen so that households (or firms) recycle more material.

From an individual's point of view, the refundable deposit creates an additional private cost of disposal-thc opportunity cost of failing to obtain a refund. As shown in Figure 18.8, with the higher cost of disposal, the individual will reduce disposal and increase recycling to the optimal social level m*.

A similar analysis applies at the industry level. Figure 18.9 shows a downward sloping market demand for glass containers, D. The supply of virgin glass containers is given by Sv and the supply of recycled glass by Sr. The market supply S is the horizontal sum of these two curves. As a result, the market price of glass is P, and the equilibrium supply of recycled glass is Mi.

By raising the relative cost of disposal and encouraging recycling, the refundable deposit increases the supply of recycled glass from S, to 5"r, the aggregate supply increases from S to S', and the price of glass falls to P. As a result, the quantity of recycled glass increases to M*, which means a decrease in the amount of disposed glass.

Sr

s;

\ / X >

\ / „ X /

---_}_

i ! 1 1 1 1 1 i

M, M* Amount of Glass

FIGURE 18.9 Refundable Deposits. Initially equilibrium in the market for glass containers involves a price P and a supply of recycled glass Mi. By raising the relative cost of disposal and encouraging recycling, the refundable deposit increases the supply of recycled glass from St to SV and the aggregate supply of glass from StoS'. The price of glass then falls to P', the quantity of recycled glass increases to M*, and the amount of disposed glass decreases.

The refundable deposit scheme has another advantage-a market for recycled products is created. In many communities public or private firms as well as private individuals specialize in collecting and returning recyclable materials As this market becomes larger and more efficient, the demand for recycled rather than virgin materials increases, therefore increasing the benefit to the environment.

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