Capturing the least costly way of reducing pollution: A shadow price approach

- A new shadow price approach to estimating marginal abatement costs is proposed.
- Contrary to what is common in the literature, the relative costs of different compliance strategies are emphasized.
- The paper rationalizes allocative inefficiency under environmental regulation.
- Trade-offs between pollutants and desirable outputs are examined under joint and non-joint pollution control.

The production analysis literature is increasingly concerned with estimating marginal abatement costs. Yet, most studies do not emphasize the ways in which pollutants may be reduced and their costs, which makes them unable to identify the least costly compliance strategy. This paper utilizes the materials balance principle to relate pollution to the employment of material inputs. A production model which allows input and output substitution, downscaling of operations, pollution control, and emission permits purchases as compliance strategies is proposed, and the implications of joint and non-joint pollution controls for the trade-off between pollutants and desirable outputs are considered. Marginal abatement costs, reflecting the least costly way of compliance, are derived by exploiting the duality between the directional distance function and the profit function.