Evaluate proposals for reducing environmental air pollution by energy E

Evaluate proposals for reducing environmental air pollution by energy taxation and emissions trading. Pollution is created as a by-product of output in most industries. It can be described as an external cost to the economy as its existence causes a loss of welfare to the population as a whole, and, in a free market, this loss of welfare will generally go uncompensated. However, that does not mean that the optimal level of pollution is zero, contrary to the environmentalist presumption, as this would mean that economic activity would have to be zero and this is illogical. Therefore, an optimal level of pollution and corresponding economic activity has to be found. According to the Pareto efficient, the ideal allocation of resources occurs when nobody can be made better off without making someone else worse off. In the case of pollution production, this can also be defined as the point of production where the marginal net private benefit (MNPB) of the polluter is equal to the marginal external cost (MEC) as a whole, as shown on diagram 1, at the level of economic activity Q*. The polluter’s total net private benefit from production is illustrated on diagram 1 as the area below the MNPB curve and total external cost is the area below the MEC curve. Using this analysis, we can see that ‘A’ is the largest area of net benefit available, thus confirming that Q* is the optimal level of activity. However, without regulation in this market it is likely the polluter will continue to operate at Q to maximize their own private benefits, although this will create an unacceptable level of external costs. Therefore, the government faces several policy choices in order to regulate pollution and keep it at an optimal l... ...mits are also effective in lowering emissions, but only if they are auctioned off and tradable in the market. If there is grandfathering (giving permits only to established firms in the industry) or output based allocation present then this would incur a greater cost to the economy than auctioning off permits, thus increasing the optimum level of emissions. Bibliography * Banzhaf, Burtraw & Palmer, Capping Emissions: Where Efficiency and Public Interest Intersect, Public Utilities fortnightly, 1st Dec 2002 * Pearce & Turner, Economics of natural resources and the environment, Harvester Wheatsheaf, 1990 * Pindyick & Rubinfeld, Microeconomics – 2nd edition, Macmillan, 1992 * Parry. I, Are Tradable Emissions Permits a Good Idea? Resources for the future Issue Brief 02-33 * DTI, Energy White Paper, TSO, Feb 2003 * www.defra.gov.uk