When pollution must be reduced by a certain percent, should every polluting firm be required to reduce pollution by the same percent as a matter of fairness? Or is there a more cost efficient way to achieve the same level of pollution reduction?
In the absence of pollution regulation, Firm A will pollute all it wants at this level.
Pollution reduction involves cost. It is reasonable to assume that the cost of additional reduction (namely the marginal cost) goes up as pollution is reduced towards zero.
Increasing marginal cost of pollution reduction in turn leads to steeply rising total cost. The height of the total cost simply maps the blue area under the marginal cost at a given level of pollution.
Firm B has similar marginal cost and total cost for pollution reduction. But its reduction cost is lower than Firm A.
For ease of comparison, let us put Firm B’s cost curves back to back to Firm A’s cost curves.
The red bar at the bottom of the upper panel indicates the total unregulated level of pollution from Firm A and Firm B.
If each firm is required to reduce pollution by the same percentage, the total pollution will be reduced as shown. Such distribution of pollution reduction results in unequal marginal costs between the two firms. The marginal cost at Firm A is much higher than the marginal cost at Firm B. The total cost of such uniform reduction is shown by stacking the total cost for Firm B on top of that for Firm A.
If the same level of pollution reduction is re-distributed so that the marginal cost for the last unit reduced at each firm is equal, would total cost be reduced?
Such re-distribution of pollution reduction involves moving more pollution reduction from the higher-cost Firm A to the lower-cost Firm B until the marginal cost at each firm is equal.
Let us add the total cost from Firm B on top of Firm A to compare the total cost of the two approaches to pollution reduction.
Indeed, re-distributing pollution reduction from higher-cost firm to lower-cost firm results in cost savings.
Instead of imposing uniform pollution reduction by a certain percentage of existing emissions, the regulatory agency could simply impose an appropriate level of pollution tax and let the firms find their own cost-minimizing level of pollution reduction. Lower-cost firms would find it more cost efficient to reduce more pollution than higher-cost firms.