All Commentary
Friday, June 1, 2001

Are People Pleased with the Efficient Amount of Pollution?

Public Goods Come with Serious Problems

It is clear that zero pollution is not a reasonable goal once we recognize that polluting creates benefits as well as costs. Long before we reduced pollution to zero, there would be so much environmental quality and so few manufactured goods that the marginal value gained from increasing pollution would be greater than the marginal cost. There is an efficient amount of pollution that maximizes the value realized from all the things we enjoy, of which environmental quality is but one. The efficient amount of pollution occurs where the marginal value of pollution equals the marginal cost (see my column last month).

Economists are so enthusiastic about efficiency that one might believe that if we ever got to the efficient amount of pollution, everyone would be pleased with it. This is not true. Indeed it is likely that nobody would be pleased with the efficient level of pollution—everyone would prefer a different level. But why? How can economists get so excited about the efficient amount of pollution if nobody likes it? Good question, and the answer provides important insights into why we have a pollution problem in the first place.

Most goods are like food, clothing, housing, and entertainment, which can be consumed in different quantities and qualities by people in the same community. This is not true of environmental quality.

Environmental quality is what economists call a public good. A given amount of environmental quality provided for one person in an area is simultaneously provided for everyone in that area. An additional person can benefit from a cleaner environment without reducing the benefits to others. This may sound like an ideal situation, but it creates serious problems. It is often difficult, if not impossible, to exclude people from the benefits of a public good; so some can benefit without paying. If too many people attempt to free-ride, less than the efficient amount of the good will be provided. Also, since everyone in a community has to consume the same quantity and quality of a public good, it is difficult to accommodate diverse preferences. For example, people who enjoy outdoor activities, such as jogging, will want extremely high air quality, while those who prefer bowling in smoky bowling alleys will hardly notice a smog alert.

The only way to harmonize different preferences for a public good is by charging people different prices for the same good. For example, since the jogger values clean air more than the bowler, the only way to satisfy both with the same air quality is to require the jogger to contribute more to providing clean air than the bowler. But there is a problem in charging for a public good. Even if a charge is imposed to pay for cleaner air, say, through taxation, there is no easy way to get people to reveal their preferences honestly to determine the right charge. People will claim little desire for clean air if higher charges are imposed on those receiving higher benefits. Of course, tax burdens are not determined from surveys on preferences but by the value of property holdings, income, and the whims of legislators. The clean-air-loving jogger may be a struggling graduate student who pays no taxes and the bowler may pay very high taxes. So even if we had the efficient level of air quality, the jogger and the bowler would be unhappy with it. The jogger would want much more spent on cleaning up the air, and the bowler would want much less.

I’ll Pay You Not to Pollute

Next consider a situation involving only the bowler and the jogger, with the bowler having the right to any level of air quality he wants, but with it possible for him and the jogger to negotiate an agreement over the pollution level. Before the negotiations start, the bowler wants more pollution than is efficient—an amount where the marginal cost of pollution is greater than the marginal value—since he receives little of the marginal value from reducing pollution but pays all of the marginal cost. With negotiations, however, the bowler will consider the marginal cost the jogger suffers from pollution because the jogger is willing to pay an amount equal to that marginal cost to reduce pollution. As long as the marginal cost of pollution is greater than the marginal value, the jogger is willing to pay enough to motivate the bowler to reduce pollution. When pollution is reduced to its efficient amount, the jogger is no longer willing to pay enough to compensate the bowler for more pollution reduction, and both have done as well as possible because of the exchange.

Similarly, if the jogger had the right to clean air, negotiations would still lead to the efficient level of pollution. The bowler would be willing to pay an amount equal to his gain from more pollution to the jogger for accepting more pollution. Consequently, the jogger finds it to his advantage to consider the value the bowler receives from having more pollution as well as the value he receives from less. So again, as long as the marginal value of pollution is greater than its marginal cost, both can gain through exchange that will increase pollution to its efficient level.

We see that everyone will be content with the efficient level of pollution as long as the costs of negotiating and enforcing an agreement are zero. Unfortunately, many people are typically affected by pollution, and it would be extremely costly, if not impossible, for them to reach a mutually acceptable agreement on the pollution level and side-payments, and then enforce that agreement. This inability to cooperate on pollution decisions through exchange explains why there would be widespread dissatisfaction with environmental quality even if we achieved the efficient level of pollution. It also explains why achieving (or even determining) the efficient amount of pollution is almost impossible.

If people in the same area could consume different levels of environmental quality depending on their preferences, efficiency could be easily achieved through market exchange. Each individual would pay for the cost of improving his private environmental quality to the point where the marginal cost equaled the marginal value. There would be no free-riding, no controversy, and no pollution problems, since everyone would have the environmental quality he was willing to pay for. But even with the problems that exist because we have to consume environmental quality commonly, we can use market incentives to do a far better job than we are doing to reduce pollution. After considering what it takes to reduce pollution as cheaply as possible in my next column, I shall begin discussing the advantages of market incentives in controlling pollution.

  • Dwight R. Lee is the O’Neil Professor of Global Markets and Freedom in the Cox School of Business at Southern Methodist University.