Price-based instruments
It needs to be stressed at the outset that the economic analysis of the instruments advocated by economists is quite technical. It is not possible to give comprehensive coverage of the ramifications of their effects on economic activity; the exposition here is very much an overview. Tietenberg (2006) gives a quite wide-ranging and accessible account of instruments applied in the environment field and Permann et al (2003) offer a more advanced approach, with quantitative analyses in appendices. Price-based instruments for dealing with environment issues take two form. One, for example a tax or subsidy, attempts to modify the operation of existing market, whereas the other, such as tradable permits and quotas, tries to create markets that did not previously exist. The economic argument for using the price mechanism stems from the recognition that that the cost structures of different activities vary and so, in contrast to regulation which imposes a standard compliance, there can be more flexibility in the response by those subject to price-based environmental policies. For instance, in the case of a tax on air emissions, a firm can elect to pay the tax or alternatively fit control equipment, the response being determined by the relative cost of the tax instrument and the cost of investment in equipment and /or procedures could apply with respect to conferring un-price benefits, whereby a subsidy would be preferred by the the supplier if it exceeded the cost of capturing formerly un-price benefits via the market. For example, as stated earlier, many-landowners of natural resources incur costs in making them available to tourists, yet cannot exclude visitors, perhaps because the cost of fencing and/or employing people to collect an entry fee would outweigh the revenue generated; a local authority may pay a subsidy to ensure the resource remains available. The subsidy might relate to management of the resources as an amenity or compensation for damage or loss of revenue from an alternative productive use, such as crops or timber. Another factor of some importance is the effectiveness of price-based instruments with respect to the burden on the public purse. Regulation through the price mechanism may lower enforcement costs; in effect, once the price instrument are implement and accepted, there can be virtual self-regulation by agents active in the market. The principle underpinning price-based instrument is that the full production or consumption costs or benefits should be estimated in order that the appropriate level of charge, tax, subsidy or grant can be ascertained to achieve a socially optimal position where the marginal social benefits and costs are equal, i.e. the full costs or benefits are reflected in market price, as shown in figure 10.2. in practice, in addition to effectiveness in the sense of achieving given targets, a priori the choice will depend on such considerations as the degree of uncertainty in administrative costs and long-term effects, projected efficiency and flexibility as economic conditions change, possible spin-off benefits, and the estimated distributional impact on consumers and producers.
Concentrating on marginal social cost, figure 10.2 is essentially a simplification of figure 9.4 in chapter 9 and indicates why an economic optimum position is gained at OS. The figure shows the private optimum at OP where marginal private cost (MPC) equals the marginal private and marginal social benefits, where MPB and MSB have been aggregated to depict a composite marginal benefit curve. At the activity level OP and price PP in a market economy, which does not take account of environmental costs, the marginal social costs (MSC) are ignored. Consequently the price does not reflect the full costs to society of the production of the good or service and its consumption. By levying a charge or tax equal to the difference between the MPC and MSC at OS an economic optimum is achieved, i.e. where MSB equals MSC. Reduction of the level of activity to the left of OS would be economically inefficient as the loss in benefit outweighs the reduction in well as suppliers, bear some of the burden of a charge or tax on suppliers as market price increase to PSC after its imposition; suppliers also bear part, as their net of tax price is PSS as opposed to PP previously.
In the context of tourism, a landing fee or bed tax has the effect explained above and in figure 10.2 if it is levied on suppliers in the first instance. A making a visit; demand falls from OP to OS. Thus, the charge or tax not only raises revenue that can be used to meet the cost of environmental protection but also reduces the pressure of demand.