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Chapter 14 equilibrium effects and market conditions

warawut ruankham
warawut ruankham

Equilibrium Effects and Market Conditions THOMAS STERNER Policy Instruments for Environmental and Natural Resource Management Presented by Warawut Ruankham 2 May 2021, NIDA, Thailand

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Chapter 14: Equilibrium Effects and Market Conditions THOMAS STERNER Policy Instruments for Environmental and Natural Resource Management Presented by Warawut Ruankham 2 May 2021, NIDA, Thailand
Content of Presentation Part I: direct and indirect effect of economic instrument (tax) Abatement and Output Reduction Output effect Part II: Revenue and other effects General Equilibrium, Environmental Taxation, and the double dividend Part III: Market Conditions Market Condition and Environmental Taxes
Goal Fulfillment, Abatement, and Output Substitution Emission from economic activity depends on pollution intensity or Rate of emission () Level of activity or size (q) Emission = where e can be reduced by (i) abatement technology and (ii) output reduction from certain market based policy instrument Goals: (i) to have certain appropriate policy with essentially no impact on total use of the product (i.e. chorine using for bleaching paper drafting tax in Sweden) (ii) Chosen instrument have the correct desirable output effect
Importance of Abatement cost and demand elasticity Inelastic demand Elastic demand Figure B: No clean technology Reduce demand to reduce pollution Effectiveness of policy depends on elasticity of product (or slope of demand curve)
Importance of Abatement cost and demand elasticity Figure C: Both abatement and output are important Increasing in price due to tax can lower output Effect of policy: -> : resulted from abatement effect -> : resulted from tax effect
Output and Abatement Effect (Algebraically) Tax or permit (T) Output q(T) Emission is a function of = ()() Total differentiate = + = + Substitute = Then, = + Express as elasticity = + -----------* total elasticity of demand = elasticity of abatement + elasticity of output The output effect is the interaction b/w slope of demand q=q(P) and shift in supply P=P(T) Or combined q=q[P(T)]
Output and Abatement Effect (Algebraically) Then, 咋= So, = + 咋 becomes 咋= 咋 + 咋倹咋倹 ----------------** Total response in emission =possibility of reducing rate of emission + product of price and tax elasticity of marginal of supply (abatement elasticity)
Output and Abatement Effect (case of tax elasticity of supply : linear and separable abatement cost) Firms maximize profit = 倹 (-e)諮 FOC: = = 0 ; = + 0 = ; = Then, = + 0 Tax effect = 0 Express as elasticity = = 0 ; = + 0 = 0 +0 Tax elasticity of supply is the relative share of marginal environment tax and marginal production cost
Output and Abatement Effect (case of tax elasticity of supply : linear and separable abatement cost) Exact size of abatement and output effect is = + 咋 = 咋 + 咋 諮 +諮 -----------*** Total response in emission =possibility of reducing rate of emission + product of price and tax elasticity of marginal of supply (abatement elasticity)
Output Effect of Subsidies Rebound effect refers to the decline in emission due to higher product price Abatement subsidy (Baumol and Oates, 1988) suggested that (i) payment for emission reductions could exceed the abatement cost , (ii) when marginal abatement cost are constant, subsidy is a repayment of abatement cost
Output Effect of Subsidies From the figure: Tax (T) causes largest increase in MC and AC, higher tax and abatement cost increase market price which leads to exit A regulation (R) of emission would not have full output effect Subsidy (S) instead will lead to a price reduction and could delay exit (possibly encourages entry)
General Equilibrium, Environmental Taxation, and the double dividend Although taxes are optimal policy instrument in terms of allocative efficiency and intensive structure, they are often resisted by those who have to pay Then, green tax reforms were proposed, whereby the revenues from environmental taxation were to be used to reduce other taxes. This idea give double or even triple dividend of environmental as well as economic improvement ( increased in employment and growth)
Taxation Generally, increasing in taxes makes higher price and lowers demand (loss in consumer surplus and excess burden of taxes) Inverse elasticity rules: Elastic good (i.e., luxuries good)- taxes seem to be effective tools as it might not distort demand Inelastic good (i.e., foods) taxes seem to be ineffective tools as it might distort demand, affect to the poor and income inequality Other rules Tax on labor (i.e., income tax) might distort allocation of working time (labor supply) and leisure Tax on factor input (i.e., land and forestry tax) which is undesirable to tax a intermediate goods (certain input will be taxed twice)
Environmental Taxation An optimal environmental tax operates through five effects (Goulder et al. 1999): 1. Abatement effect 2. Input substitution effect which refers to substitution of cleaner input 3. Output substitution effect 4. Revenue-recycling effect, a positive effect of the environmental tax that confirms a double dividend 5. Tax interaction effect, loss of consumer surplus and real wages that are due to distortion of the consumption (or input) basket and reduces labor supply and tax incomes, leading to further loss
Environmental Taxation A) Inelastic demand -steep demand -little reduction in E -large tax base B) elastic demand -large reduction in E -abatement is easy (E may go to zero) -tax base would be gone C) Non- linear demand -large reduction in E - Large tax base
Market Conditions Not all market are perfect competitive For some developing country, optimal tax for externality produced by monopoly less than standard Pigovian tax Two imperfection on optimal tax Monopoly Oligopoly or cartel
Market Conditions Monopoly produces lower than social optimal at Qm and set higher price at Pm Social optimal output is at Q0 If tax set at Pigovian rule which equals to sum of marginal damage, then monopoly would lower Q lower than Qm ( to Qmt and set even higher price at Pmt) To calculate tax charge = 撃 However, this second-best charge might not always feasible or desirable
Market Conditions Then, the second-best would be negative tax or subsidies for two main reasons Subsidize to increase supply (to overcome monopoly) Tax on emission (to overcome externality) However, it is not attractive to subsidize monopolist If monopoly is unavoidable, we should have free trade or liberalize trading to increase domestic supply Finally, policy packages should be with combined instruments (i.e., combination of an emission tax and subsidy per unit of production but not increase market power of monopolist)

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Chapter 14 equilibrium effects and market conditions

  • 1. Chapter 14: Equilibrium Effects and Market Conditions THOMAS STERNER Policy Instruments for Environmental and Natural Resource Management Presented by Warawut Ruankham 2 May 2021, NIDA, Thailand
  • 2. Content of Presentation Part I: direct and indirect effect of economic instrument (tax) Abatement and Output Reduction Output effect Part II: Revenue and other effects General Equilibrium, Environmental Taxation, and the double dividend Part III: Market Conditions Market Condition and Environmental Taxes
  • 3. Goal Fulfillment, Abatement, and Output Substitution Emission from economic activity depends on pollution intensity or Rate of emission () Level of activity or size (q) Emission = where e can be reduced by (i) abatement technology and (ii) output reduction from certain market based policy instrument Goals: (i) to have certain appropriate policy with essentially no impact on total use of the product (i.e. chorine using for bleaching paper drafting tax in Sweden) (ii) Chosen instrument have the correct desirable output effect
  • 4. Importance of Abatement cost and demand elasticity Inelastic demand Elastic demand Figure B: No clean technology Reduce demand to reduce pollution Effectiveness of policy depends on elasticity of product (or slope of demand curve)
  • 5. Importance of Abatement cost and demand elasticity Figure C: Both abatement and output are important Increasing in price due to tax can lower output Effect of policy: -> : resulted from abatement effect -> : resulted from tax effect
  • 6. Output and Abatement Effect (Algebraically) Tax or permit (T) Output q(T) Emission is a function of = ()() Total differentiate = + = + Substitute = Then, = + Express as elasticity = + -----------* total elasticity of demand = elasticity of abatement + elasticity of output The output effect is the interaction b/w slope of demand q=q(P) and shift in supply P=P(T) Or combined q=q[P(T)]
  • 7. Output and Abatement Effect (Algebraically) Then, 咋= So, = + 咋 becomes 咋= 咋 + 咋倹咋倹 ----------------** Total response in emission =possibility of reducing rate of emission + product of price and tax elasticity of marginal of supply (abatement elasticity)
  • 8. Output and Abatement Effect (case of tax elasticity of supply : linear and separable abatement cost) Firms maximize profit = 倹 (-e)諮 FOC: = = 0 ; = + 0 = ; = Then, = + 0 Tax effect = 0 Express as elasticity = = 0 ; = + 0 = 0 +0 Tax elasticity of supply is the relative share of marginal environment tax and marginal production cost
  • 9. Output and Abatement Effect (case of tax elasticity of supply : linear and separable abatement cost) Exact size of abatement and output effect is = + 咋 = 咋 + 咋 諮 +諮 -----------*** Total response in emission =possibility of reducing rate of emission + product of price and tax elasticity of marginal of supply (abatement elasticity)
  • 10. Output Effect of Subsidies Rebound effect refers to the decline in emission due to higher product price Abatement subsidy (Baumol and Oates, 1988) suggested that (i) payment for emission reductions could exceed the abatement cost , (ii) when marginal abatement cost are constant, subsidy is a repayment of abatement cost
  • 11. Output Effect of Subsidies From the figure: Tax (T) causes largest increase in MC and AC, higher tax and abatement cost increase market price which leads to exit A regulation (R) of emission would not have full output effect Subsidy (S) instead will lead to a price reduction and could delay exit (possibly encourages entry)
  • 12. General Equilibrium, Environmental Taxation, and the double dividend Although taxes are optimal policy instrument in terms of allocative efficiency and intensive structure, they are often resisted by those who have to pay Then, green tax reforms were proposed, whereby the revenues from environmental taxation were to be used to reduce other taxes. This idea give double or even triple dividend of environmental as well as economic improvement ( increased in employment and growth)
  • 13. Taxation Generally, increasing in taxes makes higher price and lowers demand (loss in consumer surplus and excess burden of taxes) Inverse elasticity rules: Elastic good (i.e., luxuries good)- taxes seem to be effective tools as it might not distort demand Inelastic good (i.e., foods) taxes seem to be ineffective tools as it might distort demand, affect to the poor and income inequality Other rules Tax on labor (i.e., income tax) might distort allocation of working time (labor supply) and leisure Tax on factor input (i.e., land and forestry tax) which is undesirable to tax a intermediate goods (certain input will be taxed twice)
  • 14. Environmental Taxation An optimal environmental tax operates through five effects (Goulder et al. 1999): 1. Abatement effect 2. Input substitution effect which refers to substitution of cleaner input 3. Output substitution effect 4. Revenue-recycling effect, a positive effect of the environmental tax that confirms a double dividend 5. Tax interaction effect, loss of consumer surplus and real wages that are due to distortion of the consumption (or input) basket and reduces labor supply and tax incomes, leading to further loss
  • 15. Environmental Taxation A) Inelastic demand -steep demand -little reduction in E -large tax base B) elastic demand -large reduction in E -abatement is easy (E may go to zero) -tax base would be gone C) Non- linear demand -large reduction in E - Large tax base
  • 16. Market Conditions Not all market are perfect competitive For some developing country, optimal tax for externality produced by monopoly less than standard Pigovian tax Two imperfection on optimal tax Monopoly Oligopoly or cartel
  • 17. Market Conditions Monopoly produces lower than social optimal at Qm and set higher price at Pm Social optimal output is at Q0 If tax set at Pigovian rule which equals to sum of marginal damage, then monopoly would lower Q lower than Qm ( to Qmt and set even higher price at Pmt) To calculate tax charge = 撃 However, this second-best charge might not always feasible or desirable
  • 18. Market Conditions Then, the second-best would be negative tax or subsidies for two main reasons Subsidize to increase supply (to overcome monopoly) Tax on emission (to overcome externality) However, it is not attractive to subsidize monopolist If monopoly is unavoidable, we should have free trade or liberalize trading to increase domestic supply Finally, policy packages should be with combined instruments (i.e., combination of an emission tax and subsidy per unit of production but not increase market power of monopolist)