Class 1: Externalities

PP410

Equilibrium


Supply: at any price p, how much firms are willing to sell

Demand: at any price p, how much consumers are willing to buy


Surpluses



Externalities (pollution)


Q1 (a): how much would the firm invest?



Q1 (b): government wants to get to q*eff


Without uncertainty both instruments reach q*eff, if set right.

Q1 (c): uncertain costs

Quantity regulation

Price regulation

Q2 (a): Chay, Greenstone (2005 JPE)

  • Research Question: What is the value of clean air (or equivalently the damage from pollution)?
  • Motivation: Important to quantify damage of pollution externality
  • Empirical Strategy:
    • Use capitalization approach in house prices
    • Use the introduction of the Clean Air Act in the mid 1970s as an exogenous change in pollution
    • Compare house price evolution in nonattainment and attainment counties
  • Empirical Question: What is the causal effect of pollution on house prices?

Q2 (b): identification

  • Identification Assumption: House prices would have evolved in parallel between nonattainment and attainment counties

Source: Chay and Greenstone (2005), Figure 2. Mean TSPs concentrations, 1967–75, by 1972 attainment status.

Q2 (b): main findings

Table 4: Impact of mid-decade TSPs nonattainment on 1970–80 changes in TSPs pollution and log housing values
(1)(2)(3)(4)
A. Mean TSPs changes
TSPs nonattainment in 1975 or 1976−9.96−10.41−9.57−9.40
(1.78)(1.90)(1.94)(2.02)
F-statistic TSPs nonattainment31.329.924.421.5
R².04.10.19.20
B. Log housing changes
TSPs nonattainment in 1975 or 1976.036.022.026.019
(.012)(.009)(.008)(.008)
F-statistic TSPs nonattainment8.56.29.36.4
R².01.56.66.73
County Data Book covariatesnoyesyesyes
Flexible form of county covariatesnonoyesyes
Region fixed effectsnononoyes
Sample size988983983983
  • Conclude that a 1% increase in pollution decreases house prices by 0.25%
  • Clean Air Act increased house prices by $45 billion in treated counties

Q2 (c): sorting

  • The problem arises when people value clean air differently, which is likely true
  • Individuals who live in and move to cleaner areas are the ones that value it more
  • Therefore house price movements represent the extra value of clean air to those individuals but not the average person
  • From a theoretical perspective, policy should be based on the value for the average person
  • Paper uses regression model to address the concern but hard to deal with convincingly

Further criticism of short run market-based approach

  • Individuals might be unaware of policy change