What is the best way to achieve the optimal level of pollution?

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Economics in Society

What is the best way to achieve the optimal level of pollution?

I am going to address the question of the best way to achieve the optimal level of pollution by focusing on market-based systems to control carbon emissions.  By discussing this area of the debate about environmental protection I will consider the strengths and weaknesses of the various ways available to governments of controlling pollution before consolidating my view that the best way to achieve the optimal level of pollution is (although not through this method alone) through market-based emissions control mechanisms.  These will play a huge, and; I believe increasingly larger role in the fight against CO2 pollution, which (almost unequivocally) contributes to global warming.

When doing their accounting and setting the price level in a competitive market, firms usually consider only the explicit costs of production; this includes wages, materials and rent for the production of its goods.  Assuming a competitive market, on the supply and demand diagram, this would be the supply curve and the marginal private cost curve as well (MPC).

An externality in production occurs when the firm produces one or more additional products, as an undesired by-product in the pursuit of producing the desired or target good.  Externalities can be either negative or positive, although are more often negative (hence pollution occurring).

The production of these additional products can be plotted on a supply & demand diagram by giving the externality a cash value.  This will usually be an upward sloping curve.  If we add the value of the externality to the value of the supply curve, and assuming pollution occurs, then this will mean that the new figures will give us the marginal social cost curve, which we would expect to be above the MPC curve (see diagram below).

If the firm’s production of its goods involves a negative externality, then it thus under-estimates the value of its goods, and sells its goods too cheaply if it does not also make a charge to cover the cost of this externality.  The firm in this example has failed to consider the true and full cost of the production of its product and the marginal social cost (MSC) to society.

The economist would argue that the best way to reduce pollution is to make the private marginal cost of production equal the marginal social cost of production.  That would the give the full cost of production back to a producer.  To do this a variety of market-based pollution control mechanisms can be employed.

Considering an example of a paint manufacturer, the firm sells a tin of paint at a cost that covers its rent, materials, wages of staff and some return for the owners of the factory (assuming only normal profit).  This means that any cost associated with the externality, (in this case the pollution of the atmosphere with gases, the local river with pollution and the surrounding soil contaminated with the pollution from the river,) is not accounted for by the firm.  Assuming a competitive market, our firm will produce paint and sell it at the equilibrium price for that quantity of units; therefore, the MPC curve is also our supply curve.  

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The externality is plotted on the diagram below as the marginal pollution cost, and the (horizontal) sum of the marginal pollution cost and the marginal private cost is the marginal social cost curve.  This is the true cost of production taking into account the private cost of production (those already considered by the firm) plus the cost of neutralising the negative externality, in this case the pollution of gas into the atmosphere.

The air pollution caused by the paint manufacturers could also have an adverse affect on the crop farmer nearby who grows vegetables.  This excess pollution causes ...

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