FIGURE 1-1 Marginal damage associated with SO2 emissions in a year (x-axis) and the marginal cost of emitting SO2 in a year (y-axis) for a hypothetical power plant (Firm 1) emitting SO2. E1 = amount of SO2 (tons) emitted by Firm 1; E* = economically optimal level of SO2 emissions; MC1 = marginal cost for Firm 1. Damages of emitting each additional ton of SO2 are assumed to be constant.

FIGURE 1-1 Marginal damage associated with SO2 emissions in a year (x-axis) and the marginal cost of emitting SO2 in a year (y-axis) for a hypothetical power plant (Firm 1) emitting SO2. E1 = amount of SO2 (tons) emitted by Firm 1; E* = economically optimal level of SO2 emissions; MC1 = marginal cost for Firm 1. Damages of emitting each additional ton of SO2 are assumed to be constant.

the externalities that we characterize may be too large or too small. The economically optimal level of SO2 emissions occurs at E* where the cost of reducing the last ton of SO2 equals the corresponding reduction in damages. Even at the optimal point, damages occur—an externality remains, even though emissions are at an economically optimal level.2

What then is the significance of the externalities presented in this study? As is clear from the diagram, whether emissions should be reduced or increased from the viewpoint of economic efficiency depends on the current level of emissions and the cost of reducing them; it cannot be determined from the size of total damages alone. However, evaluating economic efficiency requires information about the costs of abating SO2, which are outside the scope of this study. This does not mean that information about total damages is without value on its own: Plants with large total damages

2

Some economists might say that there is no externality if emissions are at the optimal level (E* in Figure 1-1). However, the committee follows Baumol and Oates (1988) in saying that an externality exists, even though emissions are at an optimal level.



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