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Edited by Jeroen C.J.M. van den Bergh
Chapter 16: Imperfect Markets, Technological Innovation and Environmental Policy Instruments
Carlo Carrarol 1. Background During the last few decades, most environmental policy analyses have focused on the development of policy instruments suitable for the regulation of perfectly competitive or monopolistic markets. However, the structure of the traditional instruments cannot be deemed appropriate when the market targeted for regulation does not possess the polar characteristics of perfect competition or monopoly. Under oligopoly, which is probably a more realistic analytical framework to describe modern industrial markets, other externalities, in addition to the environmental ones, have to be accounted for, and this drastically affects the characteristics and the effectiveness of regulatory instruments. Emission taxes (or effluent fees), along with emission controls and tradable permits, have emerged among the most important instruments for correcting environmental externalities. Emission taxes internalize the external damages associated with polluting activities. The internalization is complete when the fees equal the marginal external damages of pollution, such as in the case of Pigouvian taxes. It has been shown, however, that the socially optimal degree of internalization depends on the market structure. Under perfect competition, the desired internalization is complete, while under imperfectly competitive conditions, optimal taxes deviate from external damages, as was first noted by Buchanan (1969) for the case of monopoly. Complete internalization of external damages created by a monopolist will impose additional social costs by restricting the suboptimal (too low) output of the monopolist more than required for attaining social optimality. In this case, the optimal effluent fee will be less than marginal external damages. Under conditions of...
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