Pollution control in the economic environment

Abstract

Two liability schemes can be used by jurisdictions to ascertain firms comply with environmental protec- tion. Strict liability enforces the companies to use appropriate care. However, the consumers have to be forced to protect themselves, too, by the use of the defence of contributory negligence. Then, the social optimal behaviour of both, the firm and the consumers is reached.

As for negligence, this may induce the firm to take appropriate care. However, as wealth among firms is heterogeneous, this does not necessarily hold for all firms. Additionally, negligence induces con- sumers to purchase too much.

1 The basics

Legal rules give polluters the incentive to behave carefully. Some rules are more efficient than others. Strict liability, one of the two main liability schemes, implies that an injurer is liable for the damages done to a victim, no matter how high his level of care was. In the case of negligence, the injurer is only liable if he does not meet a certain standard of care, defined by the court. If he meets or exceeds the standard, the injurer’s liabilities will be zero.

In general, polluters are firms in competitive industries in long-run equilibrium. Polinsky considers the example of a firm emitting air pollution, which harms the surrounding households. The firms have the possibility to reduce the harm by installing filters. Anyway, there still remains some harm to the house- holds and filters increase the costs of production. To start discussing the matter, households are as- sumed to not being able to affect the damages they suffer.

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Table 1: Illustration of pollution example¹

The most efficient solution for the society is reached when the firm filters (cost of 125, see table 1). Now, two different legal rules can be considered. In the case of negligence, the firm is only liable if it does not meet a certain standard of care that means when it does not filter. Therefore, for the firm it is most efficient to filter, meet the standard and the long-run equilibrium of a price of 115 will be reached (see table 1, row 4). As the firm is not acting negligently when filtering, it will not have to pay damages to the victims. Therefore, the firm does not take these damages into the cost calculation and the price settles at 115. However, the society’s full cost of production of a unit is 125, as the damages to the victims have to be borne by the latter self but have to be considered as a cost of the product anyway. As for a price of 115, people valuing the product more than or equal 115 will purchase it. Though, those are more people than for the price of 125, at the total cost of the product. Therefore, the people valuing the product between 115 and 125 will purchase the product excessively, as the real cost of the product is 125. Hence, negligence can make firms take the efficient amount of care. However, it leads to an inefficient level of output as the market price does not reflect the full costs. The residual dam- ages are not considered by the firms when calculating the price. These damages remain anyhow even though the firms take appropriate care.

Now, it has to be considered what happens when victims may influence the residual damages by ap- plying protectionary measures. In this case, the residual damages can be influenced by the actions of the victims and the full cost of the product has to be calculated by considering the production costs and the damages occurring when the firms take care and the victims take care. Under negligence, firms take care and consumers have to bear their own losses. Therefore, they have an incentive to protect themselves. Henceforth, negligence induces both, the injurer and the victim to take appropriate care. Anyway, as the price set by the firm does not reflect the full costs of the product, negligence leads to inefficiently high amounts of consumption of the product.

The second legal rule is strict liability. In this case, firms are liable for all pollution damages to the vic- tims, no matter if they use adequate care or not. Therefore, strict liability forces firms to take all ad- verse affects of their behaviour on the victims into account. As can be seen in table 1 (row 5), it is most efficient for the firm to filter. The long-run equilibrium price reached contains the full costs of the product (125). Therefore, the societal efficient amount is purchased by the consumers. In competitive markets, strict liability induces the firms to take the efficient amount of care and additionally, it leads also to the consumers buying the efficient amount of the product, as the price of the product reflects its full cost (including the remaining damages to the victims).

Anyway, as for the victims, they have no incentive to protect themselves as they get completely com- pensated for their damages. It is therefore necessary to add a defence of contributory negligence to make the victims taking appropriate care. In this case, the injurer is only strictly liable if the victim is not contributory negligent. This leads to efficient care of both parties, the victims choose not to be con- tributorily negligent and the firms are liable for all residual damages. As the price reflects all the dam- ages, an efficient amount of the product is purchased.²

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¹ Adapted from Polinsky (2003), p.109

² See Polinsky (2003), pp.107.