Marginal Cost of Abatement
With regard to carbon emissions and other pollutants, the marginal cost of abatement is a key determinant in policy formulation if society is to reach an optimal level of production. It is, of course, a difficult and thorny issue that is often politically charged, but the analysis in this article simply explains the economics involved.
The abatement cost, by which I mean the cost that firms and industries would have to pay in order to clean up a given amount of the pollution that occurs as a by-product of its operations, varies on a case by case basis. This means that the optimal policy response must account for different scenarios as best it can. This is no easy task, and there are often many unknown parameters that make precision impossible.
In the analysis that follows I make no assertion about the validity of any claims that certain types of pollution are harmful, harmless, over-hyped, under-reported and so on. These are all calculations for other people to make, I merely present the framework for making policy decisions.
The analysis is best presented with the use of graphs.
Marginal Abatement Cost Curve
In the marginal abatement cost graph above, the MEC curve represents the marginal external cost that falls on third parties as a result of production/consumption of goods in a representative industry. I've explained this curve on a separate page, which you can read here:
As a quick reminder, these costs do not accrue to the manufacturer, they are external to its cost function and so they are ignored. This results in inefficiency, and it falls to the government to implement a corrective measure to address it.
The Marginal Abatement Cost Curve (MACC) represents the cost of cleaning up each unit of pollution that the industry creates. It is a downward sloping curve because each additional unit of pollution can be cleaned up more cheaply than the one before. At some point, it is possible for an industry to adopt zero emission technology such that any additional pollution beyond some minimal operational level can be cleaned up at no extra cost, and so the MACC slopes down towards a zero marginal cost point.
At the intersection of MACC and the MEC curve, we have an equilibrium point where the cost of a unit of pollution, i.e. the damage that it causes for third parties, is equal to the cost of cleaning it up. This occurs at a cost per unit of C, and a quantity of units of Q.
The two main policy options that governments have tended to choose, in order to get an industry to produce at this equilibrium level, are Emission Standards and Emission Fees. A standard simply imposes a fixed maximum quantity of pollution (Q), and then enforces it in law. A fee set at C per unit of pollution will internalize the cost of pollution for the industry and make it profit maximizing to voluntarily choose to produce at a quantity of Q. There are, of course, pros and cons for each of these options.