Koen commentary 2 pollution

Article: http://www.guardian.co.uk/environment/2010/feb/18/worlds-top-firms-environmental-damage

Firms cause $2.2 trillion environmental damage.

 

A recent UN study has shown that if the top firms "were forced to pay for use, loss and damage of environment" "one-third of profits would be lost".  Environmentalists have a growing concern that "no one is made to pay for most of the use, loss and damage of the environment."

 

Market failure exists when an unregulated market under or over allocation of resources towards a good or service resulting in a negative externality. In this case a demerit good is over allocated towards the production of a particular product. Demerit goods are goods towards which resources are over allocated by the free market, examples include, cigarettes and alcohol as well as pollution. Governments need to regulate the production of demerit goods, if a socially optimal level of output is to be achieved through taxation or limiting output of a firm.  

During an economic transaction, the firm emits costs and benefits towards society and itself. During production the firm has one cost: the marginal private cost, MPC. However, firms externalize their costs which society bears, represented as the firm's marginal social costs, MPC. The firm also has a benefit, marginal social benefit, MSB, the output demanded by society. As seen on the graph the MSC and MPC are not equal. This has to do with the fact that the firm is not bearing all of its costs of production, namely part of its costs are born by society. Because of this, negative externalities occur, the costs passed on to a third party by the polluting firm, for instance, dumping factory waste into a river that is used as the local water supply. The gap between the MSC and MPC represents the negative externality, in this case, of production. Furthermore, the gap between MSC and MPC represents the loss of welfare, and is represented by DWL, dead weight loss. MPC intersects MSB at Q_e and C_e, this is the point where the firm is producing at its equilibrium cost and quantity. MSC intersects MSB at Q_so and C_so, this is the social optimal point, allocative efficiency. Since market failure is described as the under or over allocation of resources towards a good or service.

 

With firms externalizing their costs the environment is being damaged. For example, fresh water supplies are poisoned, fish is over fished and will no longer be around in a couple of decades, and acid rain deteriorates the soil. When factories dump their waste into water supplies to lower their cost they are damaging the society. Locals will not be able to drink from their source due to chances of deadly illnesses caused by the pollution as well as high costs for a new source of drinking water. The fish in the oceans are depleting, making it difficult for poor local farmers to compete with the fishery industry because they have to go out farther at see. Moreover, fishing at high rates is unsustainable; firms have not thought about the long run, this bears society for finding a new way of obtaining food. Vegetables might be a solution; unfortunately, the agricultural industry is suffering due to the acid rain, caused by air pollution, which deteriorates the soil making it unfertile. Air pollution caused by CO₂ emissions further drives up the environmental damage; global warming as side effects as well as a rise in sea level. All the waste produced by firms has environmental damage which society bears.

 

The solution that governments should enforce to correct the market failure would be polluting permits. The government will auction off a certain amount of permits to polluting industries which allows them to pollute up to a certain point. If the firm wishes to pollute more than their permits allow, they will require buying more permits from other firms that do not need all their permits. Since the quantity of permits is fixed it get more expensive for firms to pollute more because more permits have to be bought. As a result, there is a huge incentive to minimize their pollution; furthermore, if firms do not need all their permits then they can sell them to other firms. As seen on the graph, the price of pollution permits rises when the total demand for permits among firms rises from Dpp to Dpp1. This way, as demand for permits rises, the cost to pollute increases, and the incentive to reduce pollution increases.