12.2Command-and-Control Regulation

benefits would be the same as the benefits to society as a whole. Thus, if no externalities existed, the interaction of demand and supply will coordinate social costs and benefits. However, when the externality of pollution exists, the supply curve no longer represents all social costs. Because externalities represent a case where markets no longer consider all social costs, but only some of them, economists commonly refer to externalities as an example of market failure. When there is market failure, the private market fails to achieve efficient output, because either firms do not account for all costs incurred in the production of output and/or consumers do not account for all benefits obtained (a positive externality). In the case of pollution, at the market output, social costs of production exceed social benefits to consumers, and the market produces too much of the product. We can see a general lesson here. If firms were required to pay the social costs of pollution, they would create less pollution but produce less of the product and charge a higher price. In the next module, we will explore how governments require firms to account for the social costs of pollution.

12.2 Command-and-Control Regulation

LEARNING OBJECTIVES By the end of this section, you will be able to:

• Explain command-and-control regulation
• Evaluate the effectiveness of command-and-control regulation

When the United States started passing comprehensive environmental laws in the late 1960s and early 1970s, a typical law specified to companies how much pollution their smokestacks or drainpipes could emit and imposed penalties if companies exceeded the limit. Other laws required that companies install certain equipment—for example, on automobile tailpipes or on smokestacks—to reduce pollution. These types of laws, which specify allowable quantities of pollution and which also may detail which pollution-control technologies companies must use, fall under the category of command-and-control regulation. In effect, command-and- control regulation requires that firms increase their costs by installing anti-pollution equipment. Thus, firms are required to account for the social costs of pollution in deciding how much output to produce. Command-and-control regulation has been highly successful in protecting and cleaning up the U.S. environment. In 1970, the Federal government created the Environmental Protection Agency (EPA) to oversee all environmental laws. In the same year, Congress enacted the Clean Air Act to address air pollution. Just two years later, in 1972, Congress passed and the president signed the far-reaching Clean Water Act. These command-and-control environmental laws, and their amendments and updates, have been largely responsible for America’s cleaner air and water in recent decades. However, economists have pointed out three difficulties with command-and-control environmental regulation. First, command-and-control regulation offers no incentive to improve the quality of the environment beyond the standard set by a particular law. Once firms meet the standard, polluters have zero incentive to do better. Second, command-and-control regulation is inflexible. It usually requires the same standard for all polluters, and often the same pollution-control technology as well. This means that command-and-control regulation draws no distinctions between firms that would find it easy and inexpensive to meet the pollution standard—or to reduce pollution even further—and firms that might find it difficult and costly to meet the standard. Firms have no reason to rethink their production methods in fundamental ways that might reduce pollution even more and at lower cost. Third, legislators and EPA analysts write the command-and-control regulations, and so they are subject to compromises in the political process. Existing firms often argue (and lobby) that stricter environmental standards should not apply to them, only to new firms that wish to start production. Consequently, real-world environmental laws are full of fine print, loopholes, and exceptions. Although critics accept the goal of reducing pollution, they question whether command-and-control regulation is the best way to design policy tools for accomplishing that goal. A different approach is the use of market- oriented tools, which we discussed in the next section.

12.3 Market-Oriented Environmental Tools

LEARNING OBJECTIVES By the end of this section, you will be able to:

• Show how pollution charges impact firm decisions
• Suggest other laws and regulations that could fall under pollution charges
• Explain the significance of marketable permits and property rights
• Evaluate which policies are most appropriate for various situations

Market-oriented environmental policies create incentives to allow firms some flexibility in reducing pollution. The three main categories of market-oriented approaches to pollution control are pollution charges, marketable permits, and better-defined property rights. All of these policy tools which we discuss, below, address the shortcomings of command-and-control regulation—albeit in different ways.

Pollution Charges

A pollution charge is a tax imposed on the quantity of pollution that a firm emits. A pollution charge gives a profit-maximizing firm an incentive to determine ways to reduce its emissions—as long as the marginal cost of reducing the emissions is less than the tax. For example, consider a small firm that emits 50 pounds per year of small particles, such as soot, into the air. This particulate matter causes respiratory illnesses and also imposes costs on firms and individuals. Figure 12.3 illustrates the marginal costs that a firm faces in reducing pollution. The marginal cost of pollution reduction, like most marginal cost curves, increases with output, at least in the short run. Reducing the first 10 pounds of particulate emissions costs the firm $300. Reducing the second 10 pounds would cost $500; reducing the third ten pounds would cost $900; reducing the fourth 10 pounds would cost $1,500; and the fifth 10 pounds would cost $2,500. This pattern for the costs of reducing pollution is common, because the firm can use the cheapest and easiest method to make initial reductions in pollution, but additional reductions in pollution become more expensive.

FIGURE 12.3A Pollution Charge If a pollution charge is set equal to $1,000, then the firm will have an incentive to reduce pollution by 30 pounds because the $900 cost of these reductions would be less than the cost of paying the pollution charge.