Chapter – 4

CHAPTER FOUR
THE ECONOMIC THEORY OF POLLUTION CONTROL
The optimal level of pollution
Minimization of waste disposal costs
From a purely economic perspective, the management of pollution control or environmental quality is
easily understood if the problem is viewed as minimizing total waste disposal costs. Broadly identified,
waste disposal costs originate from two distinct sources. The first is the pollution control (abatement)
cost: the cost that arises from society’s cleanup effort to control pollution using some kind of technology.
The second element is the pollution damage cost, which results from damage caused by untreated waste
discharged into the environment. Thus:

Total waste disposal costs = Total pollution control (abatement) cost + total pollution damage cost.

Hence, the economic problem of interest is to minimize the total disposal costs, with full recognition of
the implied trade-off between its two components: control and damage costs. This is because, from an
economic viewpoint, a dollar’s worth of investment (expenditure) on pollution control technology will
make sense if, and only if, society is expected to be compensated by benefits to be realized from the
avoidance of environmental damage that are worth more than a dollar. A good understanding of this
economic logic requires, first of all, a clear and in-depth understanding of the nature of these two types of
waste disposal costs to which we now turn.
Pollution control (abatement) costs and their salient properties
Pollution control (abatement) costs represent direct monetary expenditures by a society for the purpose
of procuring resources to improve environmental quality or to control pollution. Expenditures on sewage
treatment facilities, smokestacks, soundproof walls, and catalytic converters on passenger cars are just a
few examples of pollution control costs. These expenditures may be incurred exclusively by private
individuals, such as expenditures on soundproof walls by residents living in close proximity to an airport.
In contrast, sewage treatment facilities may be undertaken as a joint project by local and federal
government agencies.

Figure – 1

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In this case the expenditures are shared by two government bodies. In some situations a project may be
undertaken by a private firm with a subsidy from the public sector. Thus, as these examples illustrate, the
bearers of the expenditures on pollution control projects may vary, and in some instances are difficult to
identify. Despite this possible complication, the conventional wisdom is to view pollution control cost in
its entirety. To this extent the specific source of the expenditure is irrelevant. What is relevant is that all
components of the expenditure attributable to a specific pollution abatement project are fully accounted
for, regardless of the source of the funds.
In general, we would expect the marginal pollution control cost to increase with increased environmental
quality or cleanup activities. This is because incrementally higher levels of environmental quality require
investments in technologies that are increasingly costly. For example, a certain level of water quality
could be achieved through a primary sewage treatment facility. Such a facility is designed to screen out
the solid and visible material wastes, but nothing more. If a higher level of water quality is desired, an
additional expenditure on secondary or tertiary treatment may be required.
Such additional treatments would require implementation of new and costly technologies designed to
apply either chemical and/or biological treatments to the water. Graphically, we can visualize the
marginal control cost (MCC) as follows.
Figure 4.1 represents the marginal pollution control cost in graphical form. Before we proceed any
further, it is very important to understand the exact reading of this graph. First, the benchmark or total
number of units of waste that is being considered for treatment is 20. This is evident since the marginal
cost of the twentieth unit of waste (i.e. no waste treatment) is seen to be zero. Second, it is important to
note that the marginal pollution control cost increases at an increasing rate as a higher level of cleanup or
environmental quality (a movement towards the origin) is desired. The numerical example in Figure – 1
clearly indicates this. The marginal cost of controlling or treating the fifth unit of waste is seen to be $50.
However, the marginal cost increases to $200, a fourfold rise, to treat the fifteenth unit of waste. Note that
given that the benchmark is 20 units, the treatment of the fifteenth unit is equivalent to leaving 5 units of
waste untreated – which is what is shown in Figure – 1.
At this stage it is important to specify certain important technological factors that determine the position
of any marginal pollution control cost curve. More specifically, it is important to note that the marginal
pollution control cost curves are constructed by holding constant such factors as the technology of
pollution control, the possibility of input switching, residual recycling, production technology, etc. A
change in any one of these predetermined factors will cause a shift in the entire marginal pollution control
cost curve. For instance, an electric power plant that uses coal as its primary source of energy could
reduce pollution (sulfur) emission by switching from coal with high sulfur content to low-sulfur coal. In
this particular case, the effect would be to shift the marginal pollution control cost downward. Similar
results would occur if there was a significant improvement in pollution control technology, such as the
development of a new and more efficient catalytic converter for automobiles.
Finally, since pollution control costs are explicit or out-of-pocket expenditures, it is assumed that no
apparent market distortion occurs as a result of a third-party effect, i.e. an externality. In other words, for
pollution control costs, there will be no difference between private and social costs. However, this is not
to suggest that market distortion in the assessment of pollution control costs cannot exist as a result of
either market imperfection (monopoly power) or government intervention in the forms of subsidies and
taxes. As stated earlier, pollution control cost accounts for only one side of the total social costs of
pollution. Let us now turn to a detailed examination of the second component of the total pollution
disposal costs, namely pollution damage costs.
Pollution damage costs and their salient properties
When the volume of waste discharged exceeds the assimilative capacity of the environment, and is left
untreated, it can contribute to deterioration in environmental quality. The total monetary value of all the
various damages resulting from the discharge of untreated waste into the environment is referred to as
pollution damage cost.
Such damage to environmental quality may be manifested in a variety of ways, largely depending on the
amount and the nature of the untreated waste. For example, when biodegradable pollutants, such as

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sewage, phosphate-containing detergents and feedlot waste are emitted into a lake, they can lead to the
development of a process known as eutrophication. Over time, the outcome of this process is to cover a
substantial portion of the lake with green organic matter, primarily algae and weeds. One immediate
effect is a reduction in the scenic appeal of the lake. In addition, there is a negative impact on the
population of aquatic organisms, because the ability of a body of water to support fish and other
organisms depends on how much dissolved oxygen it contains. Thus, if biodegradable pollutants were
discharged into a lake and left untreated, the damage to environmental quality would be identifiable in
terms of reduced scenic attraction and decreased population of certain aquatic organisms, such as fish.
The monetary value of these adverse environmental effects constitutes pollution damage cost.
What is particularly significant about these types of pollutant is not the mere fact that they are patently
dangerous to living organisms and the ecosystem as a whole, but that because of their very slow
decomposition processes they tend to persist in the environment for a very long period of time. In other
words, their adverse environmental effects transcend present action. For example, radioactive elements
leaking from nuclear power plants today will have detrimental effects over several generations. This
makes the estimation of damage costs arising from persistent pollutants extremely difficult. Conceptually,
Figure – 2 represents the general characteristics of the marginal pollution damage cost (MDC curve).
More specifically, as discussed above, the damage cost curve measures the social cost of damage to the
environment in monetary terms, resulting from each additional unit of waste emission.

Figure – 2
A basic assumption in the construction of this curve is that damage cost is an increasing function of
pollution emissions. In other words, the damage caused by a unit of pollution increases progressively as
the amount of pollution (untreated waste) emitted increases. As the numerical example in Figure – 2
indicates, the marginal damage cost increases from $125 (the cost of the tenth unit of waste) to $500 (the
cost of the fifteenth unit of waste) as the amount of waste emissions increases from 10 to 15 units. This is,
of course, in accord with the ecological principle discussed in Chapter 2, the cumulative (nonlinear)
effect of pollution on the environment. One last issue of considerable significance to be discussed is the
fact that pollution damage costs are externalities. By definition these are costs incurred by members of a
society after the pollution damage has already occurred. This is an important factor in the determination
of the optimal level of pollution – the subject matter of the next section.
The optimal level of pollution
At the outset of this chapter it was stated that the management of environmental quality is easily
understood if the problem is viewed as the minimization of total disposal costs. It was also made clearer
that the total disposal costs are composed of two parts: pollution control and pollution damage costs.
Previously we made a considerable effort to understand the nature of these two components. Equipped

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with this information, we are now in a position to formally specify what exactly is meant by an optimal
level of pollution and how it is associated with the minimization of total disposal cost.

Figure – 3
In Figure – 3 the marginal damage cost (MDC) and the marginal control cost (MCC) curves are drawn on
the same axes. From this graph it is evident that if a pollution control measure is not undertaken, the total
amount of waste discharged would be W*. However, the socially optimal level of waste discharge is Wk,
where the usual equi-marginal condition is satisfied, i.e. MDC is equal to MCC. At this level of waste
discharge, the total control cost is represented by the area W*SWk (the area under the
MCC curve) and the total damage cost is depicted by the area OSWk (the area under the MDC curve). The
total disposal cost, which is the sum of these two costs, is shown by the area OSW*. The question, then, is
how do we know that this total cost represents the minimum? Or, stated another way, how do we know
that Wk represents the Pareto optimal level of waste emission?
We can easily demonstrate that Wk is Pareto optimal for an extended discussion of Pareto optimality) by
showing that any attempt to set the level of waste emission either above or below Wk would lead to an
increase in the total disposal cost. First, suppose that the level of waste emission is increased from Wk to
Wi. As shown in Figure 4.4, the total damage cost for this incremental emission, Wk to Wi, is indicated by
the area WkSMWi, the area under the MDC curve. However, as a result of the emission of this additional
amount of untreated waste, there will be a reduction in pollution control cost. This incremental cost
saving is shown by area WkSNWi, the area under the MCC curve. The net result of increasing the level of
waste emission from Wk to Wi is an increase in the total disposal cost by area SMN. A similar argument
can be made to show that lowering the level of the waste emission from Wk to Wj would result in an
increase in the total disposal cost by area SLR. Thus, the pollution level at Wk is Pareto optimal.
Changes in preferences and technology and their effects on the optimal level of pollution
Let us start by examining how changes in preferences for environmental quality and technology may
affect the socially optimal level of pollution by using Figures – 4A, 4B and 4C. In Figure 4.6A, let us
assume that MDC0 and MCC0 represent the initial marginal damage and control cost curves. Given this,
the optimal level of pollution would be Wk. Suppose now, because of a new environmental awareness
campaign, people’s demand for higher environmental quality has increased.

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Figure – 4
The effect of this would be to shift the MDC curve to the left since, the MDC curve shows what people
are willing to pay to avoid damage. In Figure – 4A this is shown by the shift of the marginal damage cost
curve from MDC0 to MDC1. Other factors being held constant, this change in the marginal damage cost
will alter the position of optimal level of pollution from Wk to Wj. Hence, we can conclude from this that,
other factors being equal, a preference for a higher level of environmental quality would lead to a lower
tolerance for pollution or a higher level of environmental quality – which makes a good deal of sense.
However, it is important to note that the higher environmental quality was realized at some cost; the total
disposal cost is higher at the new equilibrium (area OVW* instead of ORW*).
A similar approach could be used to analyze the effect of technology on the level of pollution that society
is willing to tolerate at a point in time. To show this, suppose that there is a technological breakthrough in
the control or treatment of a specific type of waste. Since this implies a cost saving in waste treatment, the
marginal control cost curve will shift downward to the left. This is shown in Figure 4.6B by a shift in the

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marginal control cost curve from MCC0 to MCC1. Assuming no changes in other factors, this shift will
have the effect of reducing the level of pollution from its initial level Wk to Wj.
Here again the conclusion we reach is that improvement in waste treatment technology would allow
society to reduce its level of pollution or improve its environmental quality. Moreover, the improvement
would be accomplished without an additional increase in the total disposal cost. As seen in Figure 4.6B,
when the level of pollution is Wk, the total waste disposal cost is shown by area OSW*. However, with
the new level of pollution,Wj, the total waste disposal cost is reduced to OTW*. In this particular case,
therefore, there is not only a decline in pollution, but also a reduction in waste disposal costs. This is more
like ‘you can have the cake and eat it too’. Indeed, it is a good example of the miracle of technology!
Technology may also affect the level of pollution that society would like to have in some other ways. To
see this, let us assume that there is a technological breakthrough in the treatment of a cancer caused by
exposure to a certain pollutant. Other factors being equal, the obvious effect of this is to shift the marginal
damage cost downward and to the right. In Figure 4.6C, this is shown by a shift in the marginal damage
cost curve from MDC0 to MDC1. As a result, the new optimal level of pollution,Wi, will exceed the level
of pollution present before the change in technology occurred,Wk. Here is a case, then, where
improvement in technology would lead to an increase, rather than a decrease, in the level of pollution or
a deterioration of environmental quality. However, even under this condition, improvement in technology
would lead to a reduction in total waste disposal costs. This can easily be verified using Figure 4.6C. The
total disposal cost was area OFW* before the technological breakthrough in cancer treatment occurred,
but this cost is now reduced to area OGW*.
Clearly, as the above two cases illustrate, a technological improvement that causes a shift in either the
MCC curve or the MDC curve leads to a reduction in total disposal cost. A saving in disposal cost, then,
is the unambiguous result of improved technology. However, the effect of technological improvement on
the level of pollution or environmental quality is not so straightforward. If the MCC curve were to shift to
the left due to technological advances in waste treatment, other factors being equal this would lead to a
decline in pollution, hence improved environmental quality. On the other hand, if the effect of the change
in technology were to shift the MDC curve to the right, then if other factors remained constant, the
outcome would be an increase in the level of pollution, and hence a further deterioration in environmental
quality. These are important observations to keep in mind since they provide us with a clear warning that
technology does not provide an unequivocal resolution to environmental problems.
An alternative look at market failure
Main objective here is to demonstrate how the phenomenon of market failure can be explained using the
model developed in this chapter. This is done using Figure – 5. According to this figure, the optimal level
of pollution is Wk, where the equality of marginal damage and marginal control costs is satisfied.

Figure – 5

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The question is, could this level of pollution be attained through the free operation of the market? The
answer is rather straightforward once we recognize one important difference between damage and control
costs. That is, as discussed earlier, damage costs are externalities, while control costs are not. Given this,
what is cheapest for private firms would not be cheapest for society as a whole. In other words, with
respect to the damage costs there will be a divergence between private and social costs. In general, the
tendency is for private firms to totally ignore the damage costs. This point is illustrated in Figure – 5. At
the socially optimal level of pollution, Wk, the total waste disposal cost is represented by area OSW*.
This total cost is composed of the total damage costs, area OSWk, and the total control costs, area
WkSW*. However, if this were done through the market, it would be in the best interest of private firms to
minimize control costs and ignore damage costs altogether (since damage costs are externalities). This
would move the market solution closer to W*. Thus, the optimal solution, Wk, could not be attained
unless measures were taken to make private firms internalize the externality. Hence, this is a clear case of
market failure.