(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 694

CHAPTER 18 • Externalities and Public Goods 669

Dollars
per unit
of emissions

MEC

F IGURE 18.5

STANDARDS AND FEES
Standard

The efficient level of emissions at E* can
be achieved through either an emissions
fee or an emissions standard. Facing a fee
of $3 per unit of emissions, a firm reduces
emissions to the point at which the fee is
equal to the marginal cost of abatement.
The same level of emissions reduction can
be achieved with a standard that limits
emissions to 12 units.

Fee
3

MCA
12

26

E*

Level of emissions

of abatement is less than the emissions fee. Thus it pays to reduce emissions.
Below 12 units, however, the marginal cost of abatement is greater than the fee.
In that case, the firm will prefer to pay the fee rather than further reduce emissions. It will therefore pay a total fee given by the gray-shaded rectangle and
incur a total abatement cost given by the blue-shaded triangle under the MCA
curve to the right of E = 12. This cost is less than the fee that the firm would pay
if it did not reduce emissions at all.

Standards versus Fees
The United States has historically relied on standards to regulate emissions.
However, other countries, such as Germany, have used fees successfully. Which
method is better? The relative advantages of standards and fees depend on the
amount of information available to policymakers and on the actual cost of controlling emissions. To understand these differences, let’s suppose that because of
administrative costs, the agency that regulates emissions must charge the same
fee or set the same standard for all firms.
THE CASE FOR FEES First, let’s examine the case for fees. Consider two firms
that are located so that the marginal social cost of emissions is the same no matter which reduces its emissions. Because they have different abatement costs,
however, their marginal cost of abatement curves are not the same. Figure 18.6
shows why emissions fees are preferable to standards in this case. MCA1 and
MCA2 represent the marginal cost of abatement curves for the two firms. Each
firm initially generates 14 units of emissions. Suppose we want to reduce total
emissions by 14 units. Figure 18.6 shows that the cheapest way to do this is to
have Firm 1 reduce emissions by 6 units and Firm 2 by 8. With these reductions, both firms have marginal costs of abatement of $3. But consider what happens if the regulatory agency asks both firms to reduce emissions by 7 units. In
that case Firm 1’s marginal cost of abatement increases from $3 to $3.75, while
Firm 2’s marginal cost of abatement decreases from $3 to $2.50. This cannot be