Transcript Market price

ENVS 4510: Ecological Economics
W2 on W3
Pricing Damages
Presented Jan 13, 2012
By Eric Miller
[email protected]
Slide 2
Pricing Damages: Learning Objectives
• Understand price- and quantity-based solutions to correct market
failure
• Understand some ways of pricing negative externalities
Slide 3
Externalities in the market model
• The consequence of a transaction that affects another person
without being reflected in prices. It could be positive or negative.
• Open access resources suffer from externalities
• All goods and services involve transformation of materials/energy,
using ecosystem services that are not excludable and rival 
negative externalities impacting the environment are widespread
• Add externalities into simple market model to see how market failure
impacts efficiency, and what to do about it
Slide 4
Problem: Negative externalities affecting markets
• Negative externalities lead to inefficient market outcome where more
is produced and sold than is efficient
Social Cost Curve
Price ($)
Cost of Negative
externality
Original (Market) Supply Curve
P
P
B
A
Market outcome A is inefficient
Efficient outcome is at B
Demand Curve
Q Q
Quantity
Slide 5
Solution1: Correct market price with a special tax
• Apply a tax to cover negative externality and let market adjust the
quantity supplied; called a “pigouvian” tax after Pigou (1920)
New Market Supply Curve
Price ($)
Green Tax of Cost of Externality
Original (Market) Supply Curve
P
P
B
A
B is new (efficient) market outcome
under green tax
Market Demand Curve
Q Q
Quantity
Slide 6
Solution2: Correct quantity with tradable permits
• Cap quantity of output that can be supplied with tradable permits
and let the market adjust the price of permits, after Dales (1968)
New Market Supply Curve
Price ($)
Original (Market) Supply Curve
B
P
P
A
B is new (efficient) market outcome
under tradable permit system
Market Demand Curve
Maximum Permitted Output
Q Q
Quantity
Slide 7
Solution1 or 2? (Taxes vs. Permits)
• Ease of pricing externality or determining maximum quantity?
• Market characteristics: is externality-producing market competitive?
• Administrative burden: how to allocate initial permits? How to
administer the tax?
• Durability: impact of shifting demand and supply curves?
• Political burden: is one easier to sell than another?
Slide 8
Approaches to pricing damages
Each approach is increasingly challenging, but less limiting in scope:
• Market price of the loss from externality
Method: Market price / productivity method
• (or) Price revealed by effect of externality on another transaction
Method: Hedonic analysis of affected good/service
• (or) Price is stated by a surveyed sample contingent upon paying it
Method: Contingent valuation of willingness to pay or accept payment
Slide 9
E.g. Pricing Ontario’s alternatives to electricity from coal
Cost 3 alternatives to coal versus baseline cost of sustaining coal (DSS, 2005)
Private market cost
•
+
Cost of external damages to human health
•
•
•
•
+
Willingness to pay to avoid minor illnesses (stated price)
Health care system costs of emergency room visits (market price)
Reduced productivity from lost work of health-impaired workers (market price)
Willingness to pay to avoid premature mortality (stated price)
Cost of external damages to the environment
•
•
•
=
Construction, operating and maintenance (market prices)
Fixing materials corroded from pollutants (market price)
Lost agricultural productivity from pollutants (market price)
Hypothetical cost of purchasing greenhouse gas emissions permits (market price)
Social cost of electricity
Slide 10
E.g. Pricing Ontario’s alternatives to electricity from coal
Baseline
keep Coal
Replaced by Replaced by
Gas
Gas & Nuclear
Replaced by
Clean Coal
Private market cost
$
0.04
$ 0.08
$
0.06
$
0.05
+ External health cost
$
0.11
$ 0.01
$
0.01
$
0.04
+ External environmental cost
$
0.01
$ 0.01
$
0.00
$
0.01
= Social cost (2005 CDN)
$
0.16
$ 0.10
$
0.07
$
0.11
Slide 11
References
• Dales, J. H. 1968. "Land, water, and ownership." Canadian Journal
of Economics 1(4): 791-804.
• DSS. 2005. “Cost-Benefit Analysis: Replacing Ontario’s Coal-Fired
Electricity Generation.” Report for the Ontario Ministry of Energy.
[online]
• Pigou, A. C. 1920. The economics of welfare. London, Macmillan.