Nova workboard

a blog from young economists at Nova SBE

Pollution problem in central Lisbon: imposing a tax or restricting access?

When individuals impose costs on others, without having any economic incentive to take those costs into account, we are in the presence of a negative externality. As explained by the economic theory, externalities may lead to individual decisions that are not optimal from the point of view of society as a whole. Without any intervention, the market will tend to overproduce negative externalities.

Air pollution is often presented as a classical example of a negative externality. In recent years, we have been confronted by the media with some news pointing out pollution problems in central Lisbon and claiming urgency towards action. Avenida da Liberdade, a key point for those who enter or leave the capital by car, is today one of the most polluted avenues in Europe. Several times, the legal admissible levels of air pollution were exceeded. In this context, not respecting the EU Directive of Air Quality might have severe consequences, especially when Portugal is under external assistance and so financially constrained. Would we like to pay a fine of 1.9 Million Euros plus 630 Euros per day until compliance with the EU Directive?

Furthermore, the problem is even worse due to the daily traffic congestion during rush hours. As we know, urban traffic congestion is a modern example of a “tragedy of the commons”. If we consider the trips by car along the Avenue as a good, immediately, we will agree on its non-excludable nature. However, since there is free access, there will be rivalry in consumption, that is, the access creates scarcity of space and thus congestion. 

How should this problem be addressed? As a science, Economics can offer its contribution. Indeed, from very simple models, we can extract powerful insights. The 2012 Prize for Shapley and Roth clearly demonstrates the growing acknowledgment for the use of abstract theory to ongoing efforts to find practical solutions to real-world problems.

We decided to use a simple model with marginal benefits and marginal costs. The model incorporates both pollution and congestion problems. We have assumed that there is demand for a certain good Q, which will represent the number of trips by car along the Avenue. The cost structure has two major components: (1) private costs, including costs related to car use such as fuel and maintenance, and also time costs derived from traffic congestion that drivers partially take into account; (2) external costs, which include all those costs that drivers impose on others and that they have no economic incentives to take into account (e.g. reduced air quality, increased level of noise and higher risk of certain diseases, as well as the external portion of congestion that is not internalized). The sum of private with external costs gives the social cost function.

We have assumed that until QA there is enough environmental assimilative capacity to absorb the emissions associated with the number of trips in the Avenue, and that congestion only starts after that level. In other words, below QA there are no external costs to society (no pollution and no congestion problems), but only the private costs to drivers, which we considered as constant. Then, after QA, the marginal private cost function (MCp) becomes increasing due to the portion of time costs internalized by the drivers. Additionally, after that level, the number of trips along the Avenue starts causing external damages to the society: congestion not internalized (cong) and air pollution (e). It is important to note that in our setting, we have assumed complete independence between the damages of congestion and the damages of pollution. In practice, it is plausible that there is a relationship between these two functions, which would further complicate the analysis of the problem. Here follows the graphical analysis (the Q-axis is normalized):

The optimal number of trips in the Avenue is given by Q*, where marginal social costs (MCs) equal marginal benefits (MB). At that point, from a social perspective, there are no economic incentives to increase or decrease the number of trips. Obviously, if doing nothing is a possibility, drivers will freely choose Q0, where they are minimizing their private costs.

From our simple setting, we will be able to analyze, from an economic perspective, two alternative policies to solve the pollution problem.

The first one, which is already implemented by municipal authorities, consists in changing traffic laws in a way that access is restricted. Due to restriction of access, the number of trips that starts causing congestion will be lower than QA and marginal private cost will become an increasing function after that level. However, restriction of access will change the social optimum. Since the government is trying to solve the pollution externality by restricting the access to the Avenue, in reality, it is creating a bigger problem by correcting one externality aggravating the other. Now, as traffic starts congesting at an earlier stage, the new social optimum will be lower than Q*.

An alternative policy would be the imposition of a congestion charge, covering a vaster area in the center of Lisbon (including the Avenue), similar to the one already implemented in London since 2003 (for further details: Theoretically, that charge would be a Pigouvian tax, which is, by definition, a unitary tax equal to the difference between marginal social costs and marginal private costs at the optimum. While raising revenue through the implementation of this tax, authorities force drivers to internalize the damages that were previously not taken into account. The net losses associated with higher private costs due to traffic congestion are now a net transfer of welfare from drivers to the government.

Both policies attain the objective of reducing the number of trips. However, restricting access to the Avenue leads to an inefficient outcome, since those losses incurred by drivers are not appropriated by the government. On the other hand, a Pigouvian tax will lead to an efficient outcome as it maximizes net benefits from a social perspective, that is, we will reach Q* again. Additionally, this measure will not aggravate the existing externalities.

In conclusion, our example illustrates the distinction between an efficient policy and a feasible one. While it is efficient to apply a Pigouvian tax, it might not be practical, since it imposes a higher burden to drivers than restriction of access.

Tiago Silva

Nuno Salva

Yan Yang


Fires in Portugal

Fires are a scourge that every summer assault the world. We focus on fires in Portugal, which is the country where this problem is bigger in South Europe (the total burned area over the total area of the country is bigger than in France, Italy, Greece and Spain).

First of all, we should understand the development of fires through time. Data about the number of fires and the total burned area (in hectares) from 1980 until 2010 was collected. The moving average of 7 years was calculated, and it was possible to observe that the number of fires and their dimension have been increasing during the years although a decrease in the last few years can be noticed; nevertheless it is important to point out that most of the decrease observable in the moving average charts are due to the fact that in 2008 there were very few fires. What can explain this increase is now the most important question. Therefore, we decided to investigate the relationship between temperature and fires.

After we discovered that this is not a significant variable to explain fires, we tried to look at the political agenda, to see if would affect the number of fires. To do so we ran a simple regression that turned out to be insignificant, but nevertheless suggested a positive correlation between fires and elections, and for that reason we suggest further investigation in that direction.

In a nutshell, causes of fires are still not identified, which makes it harder to create an effective policy. Nevertheless, Portugal has been developing several interventions in the forest sector, such as the creation of an environmental fund, the Fundo Florestal Permanente (FFP).

The FFP was the first environmental fund in Portugal. It was created in 2004 due to an increased concern about sustainable forest management. It is managed by Instituto de Financiamento da Agricultura e Pescas (IFAP), part of Ministério da Agricultura, Desenvolvimento Rural e Pescas, and it is financed mainly by a part of the tax on petroleum products: 0,005€/l of petrol and 0,0025€/l of diesel, limited by 30 millions euros/year.

FFP finances activities that develop its goals through subsidies, credit lines, guarantees and insurances. Its main beneficiaries are municipalities and other public entities responsible for forestry administration as well as associations of forest owners. Since 2004, the volume of subsidies increased rapidly, but from 2010 onwards it has been decreasing. We could not find data about the projects financed. This lack of transparency should be a motive of concern since it is not possible to ensure that this money is being efficiently used.



Maria Martins – 540

Sofia Amaral – 538


Congested roads are one of the worst nightmares affectingcity life. The number of cars moving through, into and out of the cities can reach dramatic levels. Consequently, whenever traffic volumesbecome greater than the road’s capacity, traffic speed slows down and the final result is congestion. Thus, trip times, car accidents and uncontrolled parking increase. From an environmental perspective, traffic leads to higher levels of harmful emission and to noise.


Local governments and administrations are thus required to take actions in order to regulate traffic congestion, introducing environmental policies that aim at modifying people’s behaviour to obtain the desired outcome. One actual policy that has been introduced in several cities is a congestion charge, whichtaxes the users of the public good in order to mitigate congestion.


A concrete example of this pricing policy is the congestion charge applied in Milan, Italy. The city counts 1.3 million inhabitants and 716.431 cars on an area of 180 km2. This policy aims at regulating traffic within the central area of the city; it has been named “Area C”, where C stands for Centre and forCongestion. Each polluting vehicle entering this area will be charged a tax of five euro. The revenues of the policy are the reduction of polluting emissions and noise, a fostered and faster public transportation system, raising money that would be invested in soft mobility infrastructures, namely cycle lanes and pedestrian zones. The whole city population can therefore enjoy an improvement in the quality of life.


According to economic theory, a pricing system will allow to reach an efficient solution, as long as the tax is paid by every pollutant– drivers in this particular case – is somehow linked to the emissions he is responsible for.

Nevertheless, some problems arise by considering the distributive effects of such a policy. In Milan the local administration had to face the opposition of the shop owners located within the Area C, who claim that the restricted access to the city centre will negatively affect their selling volumes and transportation cost and therefore their income. Furthermore, the residents of the area showed opposition towards the policy. Typically, people are more concerned about the financial burden of the fee than about the benefits that could derive from those expenses.


Some adjustments to the policy can then be made in order to reach a greater consensus. A flexible tax can be introduced, instead of a fixed fare, so that each vehicle will be charged according to its engine-power emissions. Further, whenever criticism arises, it is crucial to be transparent. The main issue with this kind of congestion charge is therefore to provide citizens with clear information about the disposal of their money; secondly, it is fundamental to share data that show the effects of the restriction on the level of emissions. An intensive investment plan in public transportation should be the priority of the local administration, in order to compensate for the restricted viability of the city centre, as well as the supply of alternative mobility vehicles: electric car sharing and free city bikes could be a desirable alternative.

The pricing mechanism appears to be a reasonable policy to cope with traffic congestion. In a real-world scenario, no policy will perfectly fit the demand and supply needs though. Governments are making efforts to come up with effective solutions to environmental problems, but the best and moreover socially accepted outcome has not been reached yet.


Mariaelena De Lio

Adrian Loeffler