Pollution and the Firm

By Harford, Jon D. | Atlantic Economic Journal, September 1998 | Go to article overview

Pollution and the Firm


Harford, Jon D., Atlantic Economic Journal


Introduction

The idea of taxing pollution in particular, or any measurable action that generates an external cost, goes back to Pigou. Broadly interpreted, the concept of Pigouvian taxation can be applied to traffic congestion, congested parks, and the exploitation of common property wildlife and fisheries, as well as a wide range of pollution emissions. At its heart, it prescribes nothing more or less than that every action should be priced so as to reflect all of its costs and benefits. The call for Pigouvian taxation generally arises because some aspect of what individuals value is not separated into distinct private parcels (possibly because it cannot be) due to its technical nature. Congestion externalities arise because at high enough levels of use, individuals interfere with one another's ability to benefit from the shared public facility whether it be roads or the hiking trails in Yosemite National Park. Emissions of sulfur dioxide spread throughout the moving atmosphere can affect many individuals at once simply because the air that any one person breathes cannot be designated separate from anyone else's air.

Kohn's book, Pollution and the Firm, explores the use of Pigouvian taxation in a gallery of models where firms create pollution-causing external costs. The models usually assume a background of perfect competition with two industries and use a static, general equilibrium framework where the fundamental decisions are how to allocate capital and labor between the industries and any related activities such as abatement or avoidance. Some models include uncertainty in a variable that affects the amount or effect of pollution, but most models assume certainty. Every formal model is accompanied by a numerical version of the same model. Although some empirical functions are referred to for some of the functions assumed in the numerical models, there is no systematic effort to relate a particular numerical model to a particular empirical model or benefit-cost analysis. In some cases, production possibilities are mapped out to show the range of possible shapes and the factors affecting them. In models that maximize the utility of the representative individual, a comparison is generally made between the laissez-faire solution and the Pareto-efficient solution brought about by a Pigouvian tax on the pollution.

The book is divided into three sections. In Part I, chapters 1 through 6, the analysis concentrates on models where the pollution experienced by the individual victims or receptor firms is directly and solely a function of the output of the polluting firms. In this section, the only method of adjustment allowed for improving efficiency is to adjust the output of the polluting and nonpolluting industries. In Part II, chapters 7 through 11, the use of abatement technology or recycling offers another way of efficiently modifying the level of pollution in the economy. In Part III, the receptor firms are assumed to have technology that allows some of the ambient concentration of pollution to be avoided. This ultimately allows the author to offer the "quadruple equality" of marginal efficiency conditions in a static economy with pollution. These conditions are MDP = MCA = MCV = MCS, where these terms are the marginal pollution damage, marginal cost of abatement, marginal cost of avoidance, and the marginal cost of substitution. All of these concepts are measured as dollars per unit of pollution. The last concept is the gap between the demand price and marginal cost of the polluting good divided by the net pollution per unit of output. In an efficient allocation, this must equal MPD when that concept is measured in terms of dollars of external cost per unit of pollution, While all the pieces of these equalities have been seen elsewhere, the presentation here offers a unifying and comprehensive look at the pieces of these relationships and of cases where the marginal conditions may not be sufficient to guarantee Pareto efficiency.

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