Check Your Understanding

1. Question

   Some opponents of tradable emissions permits object to them on the grounds that polluters that sell their permits benefit monetarily from their involvement in polluting the environment. Assess this argument.

   This is a misguided argument. Allowing polluters to sell emissions permits makes polluters face a cost of polluting: the opportunity cost of not being able to sell the permits that cover the pollution. If a polluter chooses not to reduce its emissions, it cannot sell its emissions permits. As a result, it forgoes the opportunity of making money from the sale of the permits. So, despite the fact that the polluter receives a monetary benefit from selling the permits, the scheme has the desired effect: to make polluters internalize the externality of their actions and reduce the total amount of pollution.

2. Question

   For each of the following cases, explain whether an external cost or an external benefit is created and identify an appropriate policy response.

   1. Trees planted in urban areas improve air quality and lower summer temperatures.

      a. Planting trees imposes an external benefit: the marginal social benefit of planting trees is higher than the marginal private benefit to individual tree planters because many people (not just those who plant the trees) can enjoy the improved air quality and lower summer temperatures. The difference between the marginal social benefit and marginal private benefit to individual tree planters is the marginal external benefit. A Pigouvian subsidy equal to the marginal external benefit could be placed on each tree planted in urban areas in order to increase the marginal private benefit to individual tree planters to the same level as the marginal social benefit.

   2. Water-saving toilets reduce the need to pump water from rivers and aquifers. The cost of a gallon of water to homeowners is virtually zero.

      Water-saving toilets create an external benefit: the marginal private benefit to individual homeowners from replacing a traditional toilet with a water-saving toilet is almost zero because water is very inexpensive. But the marginal social benefit is large because fewer critical rivers and aquifers need to be pumped. Marginal external benefit can be calculated as described in part a, and a Pigouvian subsidy can be provided for installing water-saving toilets.

   3. Old computer monitors contain toxic materials that pollute the environment when improperly disposed of.

      Disposing of old computer monitors imposes an external cost: the marginal private cost to those disposing of old computer monitors is lower than the marginal social cost, since environmental pollution is borne by people other than the person disposing of the monitor. The difference between the marginal social cost and marginal private cost to those disposing of old computer monitors is the marginal external cost. A Pigouvian tax on the disposal of computer monitors equal to the marginal external cost, or a system of tradable permits for their disposal, could raise the marginal private cost to those disposing of old computer monitors up to the level of the marginal social cost.