economic concept of costs
next class: employment and innovation
What comes to mind when you think of environmental policy costs?
Opportunity Cost: value of whatever must be sacrificed in order to obtain something (i.e. foregone net benefits)
Example: costs of graduate school?
Opportunity costs typically do not coincide with monetary outlays – accountant’s measure of costs
Opportunity costs are usually (but not necessarily) greater than out-of-pocket costs.
Equipment purchase, installation, operation, and maintenance
Changes in production process and/or inputs
Also, cost of time spent on permit applications, reports, etc.
Costs to government of administering, monitoring, and
Frequently small relative to private-sector compliance
Definition: Losses in consumer and producer surplus due to
rise in price or decrease in output of good and services
(caused by regulation)
Basic Story: if regulation leads to increase in price of
good, leads consumers to buy less of good and/or switch to
substitutes, leading to a decrease in surplus.
Changes in market structure
Reductions in product quality
increases in product prices can spill over into other markets
for example if regulated good is a large input to production, or industry is a large employer
typically we assume regulated sector "small" enough that it doesn't matter
Fracking = Multistage hydraulic fracturing + horizontal drilling
New process that dramatically altered US ability to extract gas and oil
Works by pumping very high pressure water into shale formations to break up the rock and release oil
Produces large amounts of wastewater which contains all sorts of bad stuff: solids, organic and inorganic chemicals, metals, and naturally-occurring radioactive materials
Water is typically disposed of using injection wells or brought to a treatment facility.
Consider a regulation which would require firms to either pre-treat or recycle water
How can we estimate the total cost of this proposal?
So full opportunity cost larger than actual expenditure, but smaller than an "engineering" approach that ignores behavioral response.
Assume aggregate demand curve:
To get aggregate supply, note that quantity is now 10,000 times bigger at every MC:
$Q = 1,000,000$
To find the new Q':
Change in surplus:
Do you think they might be large?
What are some spillovers in this setting?
• In the previous example, both consumer and producer surplus
declined even though the statutory burden was imposed solely
• This is a key point: Incidence of a tax (or regulation) is
independent of the side the tax is imposed on
Imagine that without taxes, the price at the pump would be
Consider a 50 cent excise tax levied on retailers
Now consider a rule change which would shift the statutory burden to consumers
How would this change the incidence of a 50 cent tax?
In this example, price goes up by $\$$0.3 after a $\$$0.5 tax
This tells us that consumers incur 60% of the economic burden
What determines these proportions?
In the fracking example, demand and supply had the same slope.
We typically measure responsiveness in terms of price elasticities:
Elasticity of demand:
Elasticity of supply:
Fraction paid by consumers:
Fraction paid by producers:
Consumers bear full burden if:
Producers bear full burden if:
Most often, want to know if otherwise socially disadvantaged
consumers pay a disproportionate share of costs
Do you think environmental policy is typically progress or
– Electricity tax
– Flood plain restrictions
Determined by how much of a good each group uses, and their
Either consumers, taxpayers, or shareholders
(Photo by Win McNamee/Getty Images)
Do you think the employment effects of environmental regulation are likely large or small?
Yes or no (justify your answer)
What factors determine whether the effects are large or small?
Here are some highlight from the most recent BLS monthly labor report.
Over past 12 months: hires totaled 66.7 million and separations totaled 64.2 million, yielding a net employment gain of 2.5 million
Are other firms in the same industry similarly regulated?
Can firms easily move to other locations
Greenstone (2002) found that the counties unaffected by the Clean Air Act gained 590,000 jobs relative to those affected as a result.
Reason to suspect net effects are much smaller
A recent study on a $\$$40 carbon tax found that it would reduce long run employment by 0.3 percentage points, for net job losses of about 480,000.
When might we actually care about gross numbers too?
One snarky WaPo article noted that the entire coal industry employs fewer people than Arby's.
However, as a reply noted:
The average coal salary is $\$$15 - 30 per hour, while the average fast food worker makes $\$$8.
So what really matters is how long you're out of work, and the difference in salaries.
Walker (2016) looked at workers in plants regulated under the 1990 Clean Air Act, and found that
Discussion of environmental policy in the US dominated by
But even in regulated sectors, net effects can ambiguous
Economics suggests this gets much more attention than it warrants
Next week: Jobs are a cost not a benefit!
Hypothesized in a very influential article by Michael Porter
"stringent policies should trigger greater investment in developing new pollution-saving technologies. If these technologies induce input (e.g., energy) savings that would not have occurred without the policy, they may offset part of the compliance costs"
Do you believe the weak Porter hypothesis?
Sir John Hicks (1932): "a change in the relative prices of the factors of production is itself a spur to invention, and to invention of a particular
kind-directed to economizing the use of a factor which has become relatively expensive"
Study spike in energy prices in 1970's
Find firms responded by making more efficient appliances
"Porter and van der Linde (1995b) go further, arguing that environmental regulations can actually “trigger innovation that may more than fully offset the costs of complying with them,” i.e., lowering overall production
costs and boosting competitiveness"
Do you believe the strong Porter hypothesis?
Porter and van der Linde (1995), gave several examples:
At Ciba-Geigy's dyestuff plant in NewJersey, the need to meet new environmental standards caused the firm to reexamine its wastewater streams. Two changes in its production process-replacing iron with a different chemical conversion agent that did not result in the formation of solid iron sludge and process changes that eliminated the release of potentially toxic product into the wastewater stream-not only boosted yield by 40 percent but also eliminated wastes, resulting in annual cost savings of $740,000 (Dorfman, Muir and Miller, 1992).
Similarly, 3M discovered that in producing adhesives in batches that were transferred to storage tanks, one bad batch could spoil the entire contents of a tank. The result was wasted raw materials and high costs of hazardous waste disposal. 3M developed a new technique to run quality tests more rapidly on new batches. The new technique allowed 3M to reduce hazardous wastes by 10 tons per year at almost no cost, yielding an annual savings of more than $200,000 (Sheridan, 1992).
that firms are making large mistakes
government intervention triggers attention in a way that corrects these
long run costs likely smaller if firms can innovate
possible that innovations are so great that it actually increases profits
to be useful, this has to be widespread and expected
economists skeptical, little evidence to suggest otherwise
Care about opportunity costs, not actual outlays
Although it does not effect efficiency, we are often also interested in economic incidence
In the long run, costs will be...