(Explain minimum consumption limited – why points below/above are unachievable)
Economic Causes of Environmental Pollution
Environmental pollution is basically caused due to economic actions of a firm – i.e. production of a good or service. Environmental pollution is a form of a negative externality.
Most economic actions of firms contribute towards some external cost. This is illustrated below.
The cost of producing oil, to a firm is C. However, this is only the private cost of production of oil – i.e. the cost of manufacturing oil to the firm, which includes its fixed and variable costs.
The firm pays C to produce an output of Q. However, it does not take into account the social cost of producing oil. The social cost is the private cost plus any external costs. In this case, the external cost is the vertical distance between the two supply curves, E1T. The oil factory emits harmful chemicals which damages the environment. This, in the long run, causes health problems for the local residents, as it contaminates the air, soil and water. These infected inhabitants will need to be treated at the NHS. This is ultimately funded by the government, who pays the cost of cleanup.
In order to bare this cost on the firm, the government must try to equate MPC with MSC, as the product is currently being overproduced, from society’s point of view. In order to do this, it must set policies to shift the MPC curve leftwards to the MSC curve, by basically reducing supply. At this point, the cost to the firm will be C1 at an output level of Q1. At this reduced output level, a social optimum point will be reached.
However, reducing production can lead to a firms cost increasing, as it moves leftwards on the AC curve.
If such an increase in costs comes from a more vital product, say oil, it can cause cost-push inflation in the economy.
We shall now take a real-life example of the French oil industry and a French oil company called TotalFinaElf. TFE has consistently been leading the list for the worst French polluters, followed by other French oil firms. The French government, a couple of years ago decided to implement more stringent policies in order to reduce pollution and environmental damage.
The policies that were implemented have been discussed below.
- The first policy implemented was a flat rate tax.
The tax leads to an increase in the cost of production, a reduction in production and hence a reduction in pollution. The social optimum point of production is at OQ, where the firm pays tax equal to EQ. This is equal to its marginal profit in pollution and hence there is no profit on the last unit.
However, the French government soon realised that such a policy was not very effective for a number of reasons.
It placed the same amount of tax on producers regardless of their size and regardless how much they individually polluted the atmosphere.
It was very difficult to place a monetary value on the extent of the damage and hence the tax rate.
Oil is a necessity and has an inelastic demand. For this reason, the oil producers were able to pass on most of the tax cost onto the consumer and hence it had no effect on reducing pollution caused by these firms.
- Another policy that was thought of, but not implemented was a form of regulation.
Under this policy the French government would allow production of oil of OQ barrels.
Beyond this limit, the French government decided to ban production of oil. However, this policy was not put into effect because of the fact that demand for oil is inelastic. Reducing supply, would lead to an increase in price and hence cost-push inflation. (Draw diag.)
The French government has still not decided on an appropriate policy to implement. The French government is trying to implement a policy which combines property rights and environmental taxes. They have realised that it is very difficult to extend property rights and identify the polluter.
The Kyoto Protocol
The policies implemented by various nations, to limit greenhouse gas emissions have had a fairly adverse effect on their economies and industries. The Kyoto Protocol was set up to alleviate these adverse effects and to continue pursuing the goal of reducing pollution and environmental degradation. The purpose of the mechanisms described in the protocol, entails channeling investments in energy efficient and energy conservation to countries and projects where the cost per unit of emissions reduction is lowest. This concept would entail a large-scale resource transfer from relatively energy-efficient, high cost countries to energy-inefficient, low cost countries.
The pact requires industrialised countries to reduce their greenhouse gas emissions by 8% of the 1990 levels between 2008 and 2012
The establishment of emissions reduction targets was a very complicated issue in the early phase of the international negotiations. Many countries could point to special circumstances that justified a more lax treatment of them compared to other countries. This argument was accepted to a limited extent. Notably, Russia and the Ukraine were given a zero target as opposed to the western industrialized countries that would have to reduce their emissions by 2010. The Kyoto Protocol uses a system of pollution permits which can be traded on an international market.
The USA is opposed to this treaty, because it claims that it will have a devastating effect on its economy. It claims that it will lead to serious job losses, inflation and a fall in GDP. How – We have seen that pollution occurs because of overproduction and over consumption. Reducing production will lead to more factors of production becoming unemployed, and also a fall in GDP.
This has brought various criticisms, especially from the UK. All nations claim that the USA, by a large margin, is the world’s largest polluter and hence should sign the treaty for the well-being of future generations.
“The US contains 4% of the world’s population but produces about 25% of all carbon dioxide emissions. By comparison, Britain emits 3% - about the same as India which has 15 times as many people”
Source: BBC
President Bush “Under the Protocol, the U.S. is supposed to cut its greenhouse gas emissions by seven percent. With four percent of the world's population, the country accounts for about 25 percent of the Earth's greenhouse gas emissions”
European Environment Commissioner Margot Wallström says 'But this ignorant, short sighted and selfish politician, long since firmly jammed into the pockets of the oil lobby, clearly couldn't care less. The talks in Bonn in July must now concentrate on world action independent of the U.S.' "
