To this point in Part II of the book we have generally considered the regulation of point sources, and with the exception of the spatial problem in Chapter 8, have assumed there is a one-to-one relationship between emissions and the ambient pollution level. This allowed us to measure environmental damages as a function of total emissions. In addition, we have implicitly assumed that emissions from particular sources are perfectly observable, so that responsibility for a given emission level can be assigned to a specific source. In this chapter we turn our attention to ambient pollution problems, in which environmental damage is assessed based on the concentration of effluent in the environment rather than the count of emissions at the polluting source. The ambient pollution problem has two crucial characteristics. First, ambient pollution problems often arise from non-point sources of emissions. A prominent example is agriculture, where nutrient fertilizers, animal waste, sediments, and pesticides can run off fields or leak from waste management systems into surface and groundwater. Emissions of these substances from individual agricultural producers are usually not observable. Rather, the collective consequences of all farmers’ emissions in a watershed are reflected in ambient concentrations of effluent in lakes, streams, and wells. Second, in many cases there is not a deterministic relationship between total emissions and ambient pollution problems. Instead, the relationship is stochastic, with randomness coming from weather events and other exogenous shocks beyond the control of polluters and the regulator. Once again considering the agricultural example, nutrient concentrations are generally higher in streams when the water volume is low. Similarly, heavy rains can increase the amount of nutrient and sediment runoff, thereby causing acute spikes in ambient pollution levels.

In this chapter we discuss the challenges associated with regulating ambient pollution levels. We begin in the next section by focusing on the non-point source pollution problem in a deterministic environment, which illustrates how moral hazard – i.e. the inability of the regulator to observe individual polluters’ emissions – necessitates the use of an ambient pollution tax in lieu of an emission tax. In section 9.2 we introduce a stochastic relationship between emissions and ambient pollution. We show that, under constant marginal damage, a uniform ambient tax can induce the efficient abatement effort, while under increasing marginal damage a uniform tax is only second-best optimal.