United States
Environmental Protection
Agency
Office of Air Quality
Planning and Standards
Research Triangle Park, NC 27711
FINAL REPORT
EPA-453/R-96-014 I
October 1996
Air
EPA ECONOMIC IMPACT AND
REGULATORY FLEXIBILITY
ANALYSIS OF THE REGULATION
OF VOCs FROM CONSUMER
PRODUCTS
Final Report
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nftri Protec
Chicago, N.
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Vt
O
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Economic Impact and Regulatory
Flexibility Analysis of the Regulation
of VOCs from Consumer Products
Final Report
October 1996
Submitted by
Bruce Madariaga
Lisa Conner
U.S. Environmental Protection Agency
Office of Air Quality Planning and Standards
Air Quality Strategies and Standards Division
Innovative Strategies and Economics Group
Research Triangle Park, NC 27711
Prepared by
Brian C. Murray
Jeannette L. Dempsey
Craig D. Randall
Center for Economics Research
Research Triangle Institute
Research Triangle Park, NC 27709
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DISCLOSURE
This report presents the results of an economic impact
analysis and initial regulatory flexibility analysis of final
legislation of a federal rule for volatile organic compounds
(VOC) for the Consumer and Commercial Products industry. The
analysis is the same as that submitted to the docket upon
proposal of the rule in March 1996. Copies of the report and
other material supporting the analysis are in Docket A-95-40
at EPA's Air and Radiation Docket and Information Center,
Waterside Mall, Room M1500, Central Mall, 401 M. Street,
Washington, D.C. 20460. The EPA may charge a reasonable fee
for copying.
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TABLE OF CONTENTS
Section Page
List of Figures v
List of Tables vii
1 Introduction, Regulatory Background, and
Industry Profile 1-1
1.1 Introduction 1-1
1.2 Regulatory Background 1-6
1.2.1 Regulatory Structure 1-7
1.3 Industry Overview 1-8
1.3.1 Consumer Products and VOC Content 1-8
1.3.2 Baseline Statistics for
the Affected Product Markets 1-8
1.3.3 Consumer Products Market Flow
and Potential Regulatory Influences . . . 1-11
2 Cost and Economic Impacts of Proposed Regulation . . . 2-1
2.1 Background 2-1
2.2 Overview of Response Options 2-2
2.2.1 Supply 2-2
2.2.2 Demand 2-4
2.3 Cost Analysis 2-5
2.3.1 Reformulation Costs 2-5
2.3.1.1 Product-Level Reformulation
Cost Estimates 2-5
2.3.2 Total Reformulation Costs:
All Products Reformulate 2-11
2.4 Market Analysis 2-14
2.4.1 Potential Firm Responses and Market
Effects with Product Reformulation . . . 2-14
2.4.2 Exit and Ouput Decision Model 2-15
2.4.3 Model Execution and Results 2-17
2.4.3.1 Market Baseline 2-18
2.4.3.2 Exit Analysis 2-19
2.4.3.3 Modeling the Regulations'
Effect on Market Supply .... 2-21
2.4.3.4 Market and Welfare Results . . . 2-25
2.4.3.5 Variable Cost Savings Paradox:
Windshield Wiper Fluids .... 2-32
2.4.3.6 Adjusting Welfare Costs for
Categories with Missing Market
Data 2-34
2.5 Output-Related Employment Impacts . . 2-35
2.6 Summary 2-38
ill
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TABLE OF CONTENTS (continued)
Section
3
Regulatory Flexibility Analysis
3.1 Potentially Affected Entities
3.2 Analysis
3.2.1 Baseline Market Presence of
Small Producers
3.2.1.1 Producer Characterization . .
3.2.1.2 Small Business Market
Presence: Characterized
by Sales
3.2.1.3 Small Business Market Presence:
Characterized by Number of
Employees
3.2.1.4 Small Business Market Presence:
Characterized by Product Size
3.3 Impacts Analysis
3 .4 Summary
References
Page
3-1
3-2
3-3
3-5
3-5
3-8
3-12
3-15
3-17
3-22
4-1
Appendix
A Market Model Methodology
A-l
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LIST OF FIGURES
Number Page
1-1 Comprehensive classification of emissions
from consumer and commercial products 1-5
1-2 Consumer products process flow 1-12
2-1 Market effects of the proposed regulation 2-24
3-1 Chain of ownership 3-4
3-2 Horizontal integration within 23 product
categories 3-8
3-3 Distribution of firms by size: characterized
by annual sales 3-11
3-4 Distribution of total sales by firm size 3-12
3-5 Distribution of firms by size: characterized
by number of employees 3-14
3-6 Distribution of employees by firm size 3-14
3-7 Distribution of sales by firm size: defined
by number of employees 3-14
V
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LIST OF TABLES
Number Page
1-1 Estimated Emissions Reduction from Consumer
Products 1-2
1-2 Baseline Market Value Data by Product 1-9
2-1 Product-Level Reformulation Cost Estimates 2-7
2-2 Total Reformulation Costs if All Products
Reformulate 2-13
2-3 Exit Analysis 2-22
2-4 Post-Regulatory Scenarios 2-26
2-5 Windshield Wiper Fluid Market Effects with and
Without Variable Cost Savings: 30 Percent Analysis . 2-33
2-6 Welfare Cost Adjustments for Categories With
Missing Data 2-36
2-7 Employment Effects 2-37
3-1 SBA Size Standards by SIC Code for Selected
Consumer Products Production Industries 3-2
3-2 Baseline Market Characterization Data Sources .... 3-7
3-3 Baseline Market Characterization: Characterized
by Annual Sales 3-9
3-4 Baseline Market Characterization: Defined by
Number of Employees 3-13
3-5 Product-Level Concentration Measures 3-16
3-6 Impacts and Size Distributions by Category 3-18
VI
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SECTION 1
INTRODUCTION, REGULATORY BACKGROUND, AND INDUSTRY PROFILE
1.1 INTRODUCTION
Under Title I of the Clean Air Act of 1990, the U.S.
Environmental Protection Agency (EPA) is developing
regulations to reduce volatile organic compound (VOC)
emissions from various consumer and commercial products. The
specific products subject to the regulation analyzed in this
report are 24 product categories targeted primarily for use by
household consumers (hereafter referred to as "consumer
products"). The consumer products are a subset of the broader
category, "consumer and commercial products," as defined
below. The individual consumer products subject to the
regulation are listed in Table 1-1. VOC emissions from
certain other categories of consumer and commercial products
are being controlled through separate regulations.
This report analyzes the economic impacts of these
proposed Federal regulatory strategies. Section 183(e) (1) (B)
of the Clean Air Act Amendments of 1990 defines a consumer or
commercial product as
any substance, product (including paints, consumer
and commercial products, and solvents), or article
(including any container or packaging) held by any
person, the use, consumption, storage, disposal,
destruction, or decomposition of which may result in
the release of volatile organic compounds.
1-1
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TABLE 1-1.
ESTIMATED EMISSIONS REDUCTION FROM
CONSUMER PRODUCTS
Product category
Aerosol cooking sprays
Air fresheners3
(single phase)
(double phase)
(liquid and pumps)
(solid and gels)
Auto windshield washer
fluidsb
Bathroom and tile
cleaners
Carburetor and choke
cleaners
Charcoal lighter
materials0
Dusting aids (aerosols)
(other forms)
Engine degreasers
Fabric protectants
Floor polishes and
waxes6
(Flexible)
(Nonresilient)
(Wood)
Furniture maintenance
products
General purpose cleaners
Glass cleaners
Hair sprays
Hair mousses
Hair styling gels
Household adhesives9
(aerosol)
(contact)
(constr/panel)
(aeneral DUrcose)
Proposed
VOC limit
(percent)
18
70
30
18
3
10, 35
(cold)
5, 7
(aero)
75
d
35
7
75
75
7
10
90
25
10
8, 12
(aero)
80
16
6
75
80
40
10
Emissions (tons/yr)
Baseline
2,720
8,078
12,372
8,029
397
80,522
1,356
5,873
3,961
345
276
2,860
1,097
3,860
3,585
1,413
15,461
179,613
2,421
622
67,608
Controlled
1,768
6,139
10,764
8,029
151
53,145
949
4,522
2,971
169
185
2,317
878
2,895
3,083
579
6,648
150,875
1,743
174
50,706
Emission reduction
Tons/yr
952
1,939
1,608
0
246
27,377
407
1,351
990
176
91
543
219
965
502
834
8, 813
28,738
678
448
16,902
Percent
35
24
13
0
62
34
30
23
25*
51
33
19
20
25*
14
S9
5 7
16
28
72
25*
See footnotes at end of table.
(continued)
1-2
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TABLE 1-1. ESTIMATED EMISSIONS REDUCTION FROM
CONSUMER PRODUCTS (continued)
Product category
Insecticides
(crawling bug)
(flea and tick)
(flying bug)
(foggers)
(lawn/garden)
Laundry prewash
(aerosol and solid)
(other forms)
Laundry starch products
Nail polish removers11
Oven cleaners
Shaving creams
Underarm antiperspirant1
(aerosol)
(others)
Underarm deodorant1
(aerosol)
(others)
All categories
Proposed
VOC limit
(percent)
40
25
35
45
20
22
5
S
85
5, 8
(aero)
5
60
0
20
0
Emissions (tons/yr)
Baseline
17,179
3,739
5,753
3,663
8,799
529
337
6,033
6,287
1,825
95
5,456
18,264
1,364
4,566
486,358
Controlled
7,215
1,196
2,646
2,234
2,376
354
337
3,740
5,595
1,022
60
5,347
18,264
1,146
4,566
364,788
Emission reduction
Tons/yr
9,964
2,543
3,107
1,429
6,423
175
0
2,293
692
803
35
109
0
218
0
121,570
Percent
58
68
54
39
73
33
0
38
11
44
37
2
0
16
0
25
Note: This table adapted from Table 2-1 in U.S. Environmental Protection
Agency. Study of Volatile Organic Compound Emissions from Consumer and
Commercial Products. Office of Air Quality Planning and Standards.
Research Triangle Park, NC.
* These categories were assessed assuming a reduction of 25 percent based on
reduction calculations for the remaining categories.
a Air fresheners category does not include toilet deodorant blocks.
Current California Air Resources Board (CARB) standard for single-phase _^ir
fresheners is 70 percent; standard is reduced to 30 percent 1/1/96, but
reductions were calculated based on 70 percent limit.
b Windshield washer emission reduction estimate was calculated assuming that
half of the products are formulated for "cold" areas or seasons. Either a
geographic or seasonal applicability provision would need to be developed.
c The CARB charcoal lighter emission standard is 0.020 Ib VOC per start, based
on test method specified in South Coast Air Quality Management District Rule
1174, February 27, 1991. No estimate of emission reductions was made.
d Current CARB engine degreaser standard is 75 percent. This limit is reduced
to 50 percent 1/1/96, but reductions were calculated based on 75 percent
standard.
(continued)
1-3
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TABLE 1-1. ESTIMATED EMISSIONS REDUCTION FROM
CONSUMER PRODUCTS (continued)
EPA survey data on floor waxes and polishes are not separated by type of
flooring. No estimate of reductions was made.
CARB standard for nonaerosol glass cleaners is reduced to 6 percent 1/1/96,
but reductions were calculated based on currently effective 8 percent limit.
EPA survey data on adhesives is separated into ten categories that do not
correspond with CARB categories. No estimate of reductions was made.
Current CARB standard is 85 percent. Standard is reduced to 75 percent
effective 1/1/96, but calculation was based on 85 percent. Acetone, the
principal ingredient, is currently being considered by EPA for exemption from
the VOC definition.
The CARB standards for underarm antiperspirants and deodorants refer to
content of "high volatility organic compounds' (i.e., those VOCs with a vapor
pressure of greater than 80 millimeters of mercury [mmHg] at 20" C) . Because
aerosol propellants are the only ingredients of these products with such high
vapor pressures, this measure is, in effect, a limitation on the propellant
content of the products.
1-4
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Thus, the general purpose of the regulation is to reduce the
flow of VOCs into the atmosphere from consumption and disposal
of products that contain VOCs. Figure 1-1 shows the
dissipative emissions and the disposal emissions into the air
that are the target of this regulation.1 These emissions are
distinguished from the manufacturing-related emissions that
are controlled by other forms of regulation (as are emissions
to land and water). The proposed regulatory structure and an
overview of the regulated industries are presented,
respectively, in the sections that follow.
agro-chemicals
Materials use & consumption (pollutants
embodied in commercial and consumer goods)
-'^^application to sotls of agro-ch
Figure 1-1. Comprehensive classification of emissions from
consumer and commercial products.
Source: Adapted from Stigliani, William M. Chemical Emissions from the
Processing and Use of Materials: the Need for an Integrated
Emissions Accounting System. Ecological Economics 1(4):325-341.
1990. (Figure 2).
1-5
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1.2 REGULATORY BACKGROUND
Section 183(e) (3) (A) directs the EPA to create categories
of consumer or commercial products whose use accounts for at
least 80 percent of VOC emissions in ozone nonattainment
areas. The EPA has divided this category list into four
groups and established priorities for regulation.
The design of regulatory strategies to reduce VOCs
emitted by consumer products is shaped in specific ways by the
Clean Air Act as amended. Two components of the legislation
are of particular importance:
• determining regulated entities, and
• establishing best available controls..
Regulations developed under Section 183(e) may be imposed
only with respect to "manufacturers, processors, wholesale
distributors, or importers of consumer or commercial products
for sale or distribution in interstate commerce in the United
States." The definition of regulated entities excludes
retailers and users.
The regulations affecting consumer products will require
best available controls. The EPA Administrator, on the basis
of "technological and economic feasibility, health, environ-
mental, and energy impacts," will determine the desired degree
of emissions reduction that
is achievable through the application of the most
effective equipment, measures, processes, methods,
systems or techniques, including chemical
reformulation, product or feedstock substitution,
repackaging, and directions for use, consumption,
storage, or disposal. (Section 183[e][l])
The requirement for best available controls establishes the
general environmental goal of regulation, not the means by
which regulated entities will comply.
1-6
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1.2.1 Regulatory Structure
The EPA surveyed producers of consumer and commercial
products to estimate baseline (1990) VOC emissions from these
sources.2 Based on "the survey," EPA determined that
approximately 28 percent (3.3 million tons) of VOC emissions
in ozone nonattainment areas originated with consumer and
commercial products. Approximately 500,000 tons of VOCs
(roughly 4 percent of VOC emissions in ozone nonattainment
areas) were emitted from the "consumer products" group
considered in this regulation.
The main component of the proposed regulations is a set
of VOC content limit standards, which are proposed to go into
effect in 1996, to regulate the emissions from the 24 consumer
products considered in this report. Table 1-1 includes the
proposed Table of Standards (TOS) for consumer products. All
such products manufactured after a specified date in 1996
cannot be sold in the U.S. unless the VOC content of the
product falls at or below the limits established in the TOS.
In addition to compliance with the TOS, the proposed
regulations include administrative requirements for code-
dating products to identify the product and its date of
manufacture.
This report includes an overview of the consumer products
industry and an analysis of economic impacts on the affected
entities. An economic model of the consumer products industry
was developed and applied to baseline data for the industry to
obtain estimates of the potential market price and quantity
effects associated with imposing the proposed TOS on consumer
products producers. In addition, a Regulatory Flexibility
Analysis was performed to estimate the impacts of the
regulation on small businesses that produce consumer products.
1-7
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1.3 INDUSTRY OVERVIEW
In this section we present a descriptive and statistical
overview of the consumer products industry to provide some
context for baseline conditions prior to the proposed
regulations.
1.3.1 Consumer Products and VOC Content
Table 1-1 includes a list of the consumer products
subject to the regulation, along with the baseline emissions
estimates from the consumer and commercial products emissions
survey.
Consumer products comprise just under 500,000 tons of
baseline (1990) emissions per year, which is approximately 15
percent of the total VOC emissions from all consumer and
commercial products—and 4 percent of total VOC emissions from
all sources--in ozone nonattainment areas. The proposed
regulations are expected to achieve a 25 percent reduction in
VOC emissions from these sources.3
The largest single emissions category is hair sprays,
accounting for approximately 180,000 tons/yr, or 37 percent of
the total emissions for consumer products. Other large
sources include auto windshield washer fluids (81,000 tons/yr}
and household adhesives (68,000 tons/yr).
1.3.2 Baseline Statistics for the Affected Product Markets
Table 1-2 reports the baseline market value data for all
product groups subject to the regulation. These data are from
the 1992 U.S. Census of Manufactures and are reported as value
of shipments and quantities where that data are available
(four cases) .
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TABLE 1-2 . BASELINE MARKET VALUE DATA BY PRODUCT
Value of shipments
($MM)
Product
Aerosol cooking sprays
Air freshener
Single-phase
Double-phase
Li quids /pump sprays
Solids/gels
Automotive windshield washer fluids
Cold climate areas
All other areas
Bathroom and tile cleaners
Aerosols
All other forms
Charcoal lighter material (mm/gal)
Carburetor-choke cleaners
Dusting aids/ furniture maintenance
products
Aerosol
All other forms
Engine degreasers
Fabric protectants
Floor polishes /waxes (mm/gal)
Products for flexible flooring mats
Products for nonresilient flooring
Wood floor wax
General purpose cleaners
Glass cleaners
Aerosols
All other forms
Hair sprays
Hair mousses
Hair styling gels
Household adhesivesc
Aerosol
Contact
Construction and panel
General purpose
Insecticides
Crawling bug
Flea and tick
Flying bug
Foggers
Lawn and garden
Laundry prewash (mm/lb)
Aerosols /sol ids
All other forms
SIC code
20791-51b
28423-81(85)
28423-15
28423-30
28995-93
NA
28424-15
NA
NA
28424-21(23) (25)
28412-04(05) (06)
28423-11
28443-63 (64)
28443-26
28443-41
2891
28799
28799-12 (17)
28799-45
28799-21(24)
28799-86b
28795
28412-61
1992
214.
512.
29.
122.
61.
NA
185.
NA
NA
288.
503.
256.
774.
139.
132.
0
8
4
8
1
1
0
6
6
7
4
2
2,293.2
415.
133.
84.
81.
191.
72.
6
9
4
8
2
7
1990a
239.
430.
24.
103.
58.
NA
155.
NA
NA
241.
518.
215.
712.
128.
121.
2,224
386.
124.
78.
76.
177.
74.
6
8
7
2
7
5
9
7
5
7
2
6
.4
5
5
5
1
8
9
See footnotes at the end of table.
(continued)
1-9
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TABLE 1-2. BASELINE MARKET VALUE DATA BY PRODUCT
(continued)
Value of shipments
($MM)
Product
SIC code
1992
1990a
Laundry starch products
Nail polish removers
Oven cleaners
Aerosols/pump sprays
Liquids
Shaving creams
Deodorant/antiperspirant
Aerosol
Nonaerosol
Total
28423-48
28447-45
28423-21
28441-49
28447-31
28447-35
49.4
46.9
64.6
270.1
176.1
1,019.0
8,118.5
41.5
43.1
54.3
248.5
162.0
937.5
7,580.7
Source: Dodge Construction Potentials as reported in the Statistical Abstract of
the United States, 1992 (Table 1208, p. 708).
a Adjusted based on ratio of 1990 and 1992 Value of Shipments at 4-digit SIC
level.
b Value of Shipments for Aerosol Cooking Sprays was estimated by taking the
value of shipments for all cooking oils (SIC 20791-52 (53) (54) (59) (98) and
(00) ) and multiplying by the estimated cooking spray share of all cooking oils
revenues (.1659). Efforts to derive to cooking spray share from secondary
sources and trade groups were unsuccessful; therefore, the share was estimated
through primary data collection at supermarkets in Durham, NC, in July 1995.
c Value of Shipments for Household Adhesives was computed by taking the value of
shipments for General Adhesives and Sealants (SIC 2891) and multiplying this
value by the ratio of new residential floorspace to all new floorspace
constructed from 1980 to 1990 (.6103).
1-10
-------
Total market value for all of the regulated consumer
products is approximately $7.6 billion (1990 $}. The highest
value of shipments category is household adhesives ($2.2
billion), followed by all insecticides combined ($843.4
million), then Hair Sprays $712.7 million).
1.3.3 Consumer Products Market Flow and Potential Regulatory
Influences
Figure 1-2 depicts the process by which economic forces
bring consumer products to the market. Focusing first on
supply factors, raw materials and other inputs are combined in
the manufacturing stage. The manufacturing process involves
mixing the materials according to specific formulae and
producing a product with distinct performance characteristics.
The manufactured product is then packaged and distributed to
outlets for consumer purchase.
The demand for consumer products is fundamentally the
result of household consumption decisions. These decisions are
made based on tastes and preferences of household members for
different (potential) items in the household "commodity
bundle," subject to the prices of consumption items and an
overall budget constraint. The price of a consumer product
relative to both the price of other commodities and the budget
will determine how much of the product a household will demand
(possibly zero). With rare exceptions, we would expect to see
a reduction (an increase) in the quantity demanded of a
product if its price rises (falls), all else equal.
Product demand can be viewed as the collective decision-
making of all relevant households regarding consumption of the
product in question. Product supply can be viewed as the
collective decisionmaking of all relevant firms regarding the
production of the product in question. Product demand and
supply interact in the marketplace, where prices are estab-
1-11
-------
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lished that equate the quantity supplied by firms with the
quantity demanded by households.
Firms in the consumer products industry may engage in
one, two, or all three stages shown on the production side of
Figure 1-1. In many cases, one firm will market and
distribute a product that it contracts to have made by an
independent manufacturing firm. The larger companies are
likely to be integrated through all stages of production.4
The existence of different firm structures is relevant in
assessing firm-level impacts of the proposed regulations.
The proposed regulation prohibits the sale of a consumer
product after a certain date if the VOC content exceeds the
product category limit. Thus, this restriction's direct
"point of impact" for the industry falls on the distribution
stage. However, this restriction works its way through the
other channels of production. For instance, while the
regulation does not explicitly prohibit the manufacture of
noncompliant products, it would be pointless to manufacture
products that cannot be sold. Thus, either a new formula
would have to be developed for manufacturing the products or
the products would be pulled from the market.
Reformulation involves an investment in research and
development (R&D) to create a new formula that allows the
manufactured product to comply with VOC standards and possess
market-valued performance standards. Since the formula is a
fixed input into the manufacturing stage, the cost of
reformulating a specific product would seem to fall directly
on the firm controlling the manufacturing stage. If that firm
is different from the firm controlling the distribution stage-
on whom the sales restriction falls directly--the issue of who
bears the cost is a little less clear.
1-13
-------
In the section that follows, the potential cost and
economic impacts are estimated within the context of a market
model. These impacts are then evaluated in terms of their
effects as small producers.
1-14
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SECTION 2
COST AND ECONOMIC IMPACTS OF PROPOSED REGULATION
This section assesses the costs incurred to comply with
the proposed consumer products regulation and examines the
economic impacts of these costs as they are absorbed by
producers and consumers of regulated products through market
processes. While the effects of this regulation may extend
outside of the markets in which the regulated products are
traded (e.g., labor and material input markets), the focus
here is on the direct effects in the markets for the regulated
consumer products. The effects of other regulations that may
simultaneously affect the consumer products industry are not
estimated.
2.1 BACKGROUND
The EPA plans to control VOC emissions from the targeted
consumer products categories by establishing specific VOC
content limits for each category. Using estimates for the
fixed and variable costs of reformulation, the potential
impacts of the proposed regulation are analyzed both from a
static perspective where alternatives to reformulation are
ignored and from a dynamic perspective where response options
are considered in the context of a market model. The market
analysis provides estimates of the potential changes in market
prices and quantities, and welfare effects—a quantification
of how the costs are distributed among producers and consumers
of consumer products.
2-1
-------
The reader should keep in mind that all effects modeled
in the analysis are relative to the baseline situation in
1990. Thus, the "potential" changes modeled must be viewed as
if the situation is now as it was in 1990. In reality, the
industry has changed since 1990--in ways that the model might
project and otherwise. Data were not available to compare
the model results, which are based on regulatory responses,
with what has actually occurred since 1990 to validate the
model. However, it is worth noting that some regulatory cost
effects (e.g., reformulation costs) quantified in this
analysis may already have been realized since 1990.
Correspondingly, some of the potential emissions reductions
may also have been realized since 1990. Thus, the costs and
benefits of the proposed regulation cannot be evaluated in a
truly marginal perspective from the time of proposal. To the
extent that lower VOC products have been introduced to the
market since 1990, the cost and economic impacts in this
report may overstate the cost and economic impacts of the
proposed regulation.
2.2 OVERVIEW OF RESPONSE OPTIONS
The regulation to reduce the VOC content of consumer
products will affect both production decisions for the
suppliers of the products and consumption decisions for the
demanders. Before developing an economic model to analyze
these regulations, we briefly characterize the scope of
responses available to producers and consumers.
2.2.1 Supply
The EPA is proposing a set of limits for the VOC content
of specific consumer products produced after 1996. The
proposed VOC limits are presented in Table 1-1 in Section 1.
Firms that produce products that exceed these limits have two
2-2
-------
choices regarding those products: (1) reformulate the
products so that the VOC content complies with the limit, or
(2) remove the product 'from the market.
Firms will presumably choose the option that maximizes
net benefits, as measured by the expected (discounted) value
of the profits generated under each option, less the
(discounted) cost of each option. The modeling framework
assumes that firms will reformulate if that is the net
benefit-maximizing option. It is possible that firms may be
unable to reformulate their products fast enough to meet the
content limits requirement, because of the timing of the
regulation or constraints on the resources that can be
allocated to reformulation. If a time extension is not granted
for the noncompliant product and technological and market
conditions allow, they may increase their production of
within-limit products to compensate for the reduction in over-
limit products until the firm makes long-run adjustments to
adapt to the product-line restrictions. This strategy may be
temporary until the over-limit product(s) can be successfully
reformulated, or it may reflect a permanent response to the
regulation.
The compliance strategy decision is likely to be
complicated by issues other than cost that relate to the
profitability of reformulation. If a product serves a narrow
market niche, reformulation may fundamentally alter the
product's attributes and erode the niche position. In such a
case, the producer may not find choosing reformulation
profitable. Although concerns regarding the regulation's
constraints on product differentiation may be real in some
cases, this complexity is not explicitly addressed in the
quantitative analysis that follows, primarily because of the
difficulty in observing both levels of and changes in product
differentiation. Moreover, the proposed limits have been
2-3
-------
determined technologically feasible, subject to Best Available
Control Technology, which implies that the reformulation will
not fundamentally alter the functions that the product can
perform.
Often, product reformulation involves an investment in
research and development(R&D) to develop a compliant product.
The extent of the reformulation necessary to bring a product
into compliance can vary from product to product. In some
cases, compliance can be achieved for a particular product
without large R&D investments because its formula is similar
enough to an existing formula or other product undergoing
reformulation. A major reformulation, as discussed here,
typically requires a significant resource and time commitment.
The process can take several years and is divided into a
number of different stages. The firm may also need to alter
its capital equipment to produce the reformulated product.
2.2.2 Demand
The consumer products regulation can be expected to
induce changes in the prices of the affected products. A
consumer may alter his/her selection of consumer products
based on the relative prices of the consumer products and on
the relative prices of substitute goods and services. For
example, consumers may opt for a non-aerosol product rather
than its aerosol alternative if the regulation-induced change
in prices increases the relative price of the aerosol product.
Moreover, a potential user of an aerosol product facing
reformulation may even opt for a different product alternative
if the price rises too much (e.g., substitute from
insecticides to some other form of pest control). The consumer
may not necessarily switch to another alternative in the face
of higher prices for a consumer product but may respond by
using less of the product. All of these factors combine to
2-4
-------
suggest that the quantity demanded of a product is likely to
drop if the price rises relative to its substitutes.
The reformulated products may also possess different
characteristics that affect their demand. For instance, VOC
content reduction in a typically high-VOC product may change
consumers' perceptions of the product's performance,
durability, and ease of application. The lower VOC content
may also work as a signaling device for the "green" consumer
in pursuit of products deemed more friendly to the
environment. For example, in view of VOC content restrictions
on paints and coatings (a separate regulation from the one
considered here), some manufacturers currently produce zero-
VOC-content coatings that are marketed as "clean air"
coatings. These factors collectively affect the benefit
consumers derive from using the product and thus affect their
willingness to pay for the reformulated product versus other
product alternatives.
2.3 COST ANALYSIS
The consumer products regulation will cause firms that
make products that exceed the allowable VOC content specified
in the TOS to either reformulate or pull the product from the
market. Both options entail compliance costs. The first
option involves reformulation costs for consumer product
producers, while the second option entails opportunity costs
(forgone profits). We now evaluate the reformulation costs;
forgone profits will be evaluated below.
2.3.1 Reformulation Costs
2.3.1.1 Product-Level Reformulation Cost Estimates.
Whether reformulation is a feasible response for the proposed
VOC content limit regulations is an empirical issue that
varies by firm and product-specific factors as well as by
timing specifications of the regulation. Since there is not
2-5
-------
sufficient data in this study to observe these firm and
product-specific factors, costs are evaluated for
representative products facing a typical reformulation in
response to the regulations.
Reformulation cost estimates for representative products
in each of the categories subject to the regulation are
presented in Table 2-1.*5 For each product, cost estimates are
broken down accordingly:
• initial one-time (fixed) costs
small product
large product
• variable costs
small product
large product.
The fixed costs consist primarily of research,
development, and marketing costs for the reformulated product,
but also may include capital equipment costs. The variable
cost effects primarily reflect (annual) changes in material
costs for the reformulated product. Note that the effect can
be negative as is the case with one category of windshield
wiper fluids, indicating that material costs are projected to
be lower for the reformulated product.
The Chemical Specialties Manufacturers Association (CSMA)
provided cost estimates for most of the categories. While
these cost estimates are the best available, EPA cannot attest
to their accuracy. CSMA provided separate estimates for small
and large products. The large/small product size threshold
for each category was determined by the product size level at
which approximately half of the product category volume is
produced by products larger than the threshold product size
and the remainder is produced by products smaller than the
threshold level.6
Chemical Specialties Manufacturers Association (CSMA) provided
estimates.
2-6
-------
TABLE 2-1. PRODUCT-LEVEL REFORMULATION COST ESTIMATES
Category
Aerosol cooking sprays
Air freshener: single-phase
Air freshener: double-phase
Air freshener: liquids/pump
sprays
Air freshener: solids/gels
Automotive windshield wiper
fluids: cold climate
Automotive windshield wiper
fluids: not cold climate
Bathroom and tile cleaners:
aerosols
Bathroom and tile cleaners: not
aerosols
Carburetor and choke cleaners
Dusting aids: aerosols
Dusting aids: not aerosols
Engine degreasers
Fabric protectants
Floor polishes /waxes: flexible
flooring
Floor polishes/waxes:
nonresilient flooring
Floor polishes/waxes: wood
floor wax
Furniture maintenance products:
aerosols
General purpose cleaners
Glass cleaners : aerosols
Glass cleaners: not aerosols
Hair sprays
Hair mousses
Hair styling gels
Household adhesives: aerosols
Household adhesives: contact
Household adhesives:
construction
Fixed costs ($1995)
Small
product
100,000
75,000
40,000
75,000
75,000
10,000
10, 000
100, 000
100,000
75, 000
30,000
25,000
100,000
50,000
75,000
75,000
75,000
50, 000
10,000
50, 000
60,000
140,000
140,000
140,000
88,421
88,421
88,421
Large
product
300,000"
150,000a
70,000a
150,000a
150,000"
20,000a
20,000a
275,000a
275, 000a
150,000a
100,000a
70,000a
150,000a
400,000a
130,000a
130,000a
130,000a
350,000a
170,000a
170,000a
270,000a
420,000b
420,000b
420,000b
255,263C
255,263C
255,263C
Variable
Small
product
10,000
50,000
5,000
10,000
50,000
10,000
-5,000
0
0
10,000
10, 000
10,000
17,500
10,000
0
0
0
0
0
0
0
0
0
0
0
0
0
costs ($1995)
Large
product
100,000a
250,000"
25,000a
50,000"
200,000a
30,000"
-15,000a
0
0
434,000a
100,000"
100,000"
770,000a
100,000"
0
0
0
0
0
0
0
0
0
0
0
0
0
See footnotes at end of table.
(continued)
2-7
-------
TABLE 2-1.
PRODUCT-LEVEL REFORMULATION COST ESTIMATES
(continued)
Category
Household adhesives : general
purpose
Insecticides: crawling bug
Insecticides: flea and tick
Insecticides: flying bug
Insecticides : f oggers
Insecticides: lawn and garden
Laundry prewash:
aerosols /sol ids
Laundry prewash: not
aerosols /sol ids
Laundry starch products
Nail polish removers
Oven cleaners: aerosols/pump
sprays
Oven cleaners: liquids
Shaving creams
Antiperspirants
Deodorants
Charcoal lighter material
Fixed
Small
oroduct
88,421
200,000
125,000
150,000
150,000
100,000
150,000
100,000
50,000
88,421
75,000
60,000
140,000
140,000
140,000
100,000
costs ($1995)
Large
oroduct
255,^63°
l,000,000a
300,000a
400,000a
450,000a
300,000a
250,000"
150,000a
100,000a
255,263C
250,000a
150,000a
420,000b
420,000b
420,000b
200,000a
Variable costs ($1995)
Small
croduct
0
0
0
0
0
0
100,000
0
5,000
0
0
0
0
0
0
10,000
Large
oroduct
0
0
0
0
0
0
200,000"
0
10,000a
0
0
0
0
0
0
50,000a
a Chemical Specialties Manufacturers Association (CSMA) provided estimates.
b Radian Corporation. "Volatile Organic Compounds Emissions from Consumer and
Commercial Products: Underarm Deodorants and Antiperspirants." Draft report
prepared for U.S. EPA, OAQPS. December 1991.
c Average of CSMA estimates.
-------
For several product categories where CSMA was unable to
provide reformulation costs estimates—personal care products,
primarily--we relied on" reformulation cost estimates from a
study by Radian Corporation.7 Large product costs for these
products are estimated to be $420,000. Based on the average
3:1 ratio of large:small product fixed costs from the CSMA
estimates, we projected small product fixed costs of $140,000.
The Radian study indicated no variable cost effects.
For the product categories not specifically covered by
the CSMA estimates or the Radian study, we used the simple
average of the CSMA estimates for small and large products as
reformulation cost proxies, since these were miscellaneous
specialty products, not personal care products.
The average fixed reformulation cost for large products
falls in the $200,000 to $300,000 range. There is substantial
variability across categories, both in the level of costs and
in the ratio of small to large product costs. CSMA could only
discern variable cost effects for 15 product categories. For
one of these categories, automotive windshield wiper fluids
not for cold climates, variable cost savings are estimated.
The potential environmental benefit of the proposed VOC
restrictions is an annual reduction in total VOC emissions. To
ultimately place benefits and costs of the regulation on a
comparable basis, costs should also be expressed on an annual
basis. The initial fixed costs of reformulation must be
amortized over the useful life of the investment. The
annualization formula for an initial cost carried over L years
is
f = F«{[I»(1+I)L /[(1+I)L -1]} (2-1)
where f is the annualized cost, F is the initial lump sum cost
and I is the discount rate. As L gets large, f approaches the
value of a perpetual annuity f=F»I. If a fixed-life assump-
2-9
-------
tion is used to annualize the fixed cost of reformulation,
this would imply that a consumer product must be reformulated
every L years. This presents a problem in terms of estimat-
ing the cost of a regulation for all baseline products. For
instance, if some baseline product formulas were near the end
of their useful life, i.e., in need of a new formulation to
remain in the market, the constraints imposed by VOC-content-
induced reformulation might be negligible. On the other hand,
if an over-limit product had recently been reformulated, the
regulation would force its producer to create a new formula to
replace this formula with an otherwise long useful life. By
accelerating the need for a new formula to the present,
instead of several years from now, this producer bears
additional costs.
As a practical matter, it is not possible to determine
the remaining useful life of the formula for each product in
the baseline and thereby have product-specific amortization of
fixed reformulation costs. Moreover, it seems plausible that
the R&D directed toward reducing VOC content for a particular
product in baseline would be of value for future formulations
of that project, thus extending the useful life of the VOC re-
duction effort. Given the uncertainty of determining the re-
maining useful life for each product, the likelihood that cur-
rent R&D focusing on VOC reduction has benefits that extend
beyond the current product formula, and given that (at 7 per-
cent) the annualization formula for a finite-lived investment
approaches the formula for an infinitely lived investment for
investments of 20 years and beyond, the annualization formula
f=F«I is used in this analysis. For example an initial fixed
cost of $300,000 would annualize to 0.07»$300,000 = $21,000.
This particular annualization formula is based on the notion
that the reformulation produces a perpetual stream of
emissions reduction benefits. Thus the annualized cost of the
investment can be viewed as the forgone perpetual annual yield
of the funds applied to alternative uses. The annualized fixed
reformulation costs are added to the annual variable
2-10
-------
reformulation costs (where applicable) to compute the total
annual reformulation cost. It is important to recognize that
the infinite life annualization formula does not necessarily
produce a lower-bound cost estimate, since it would overstate
the costs for a product that would soon be changing their
formula for nonregulatory reasons.
In the cost and market analyses that follow, all dollar
values are expressed in their 1990 equivalents to coincide
with the selected baseline year. Cost estimates are deflated
to 1990 dollars using the gross domestic product (GDP) price
deflator8 to derive annualized cost estimates.
2.3.2 Total Reformulation Costs: All Products Reformulate
We begin the analysis with the conservative assumption
that all products exceeding the regulatory limits will be
reformulated. We then apply the per-product reformulation
costs from Table 2-1 to all current (1990 baseline) products
over the proposed limits to estimate the total cost of
reformulation for these product categories. In this regard,
we present a high-bound estimate of aggregate producer costs,
since the option to employ a potentially preferred action
(product withdrawal) is ignored.
In this section, aggregate reformulation costs are for
all consumer products sold in the U.S. determined to be over
the regulatory limit. To make this determination, we referred
to data for the products reported in the Consumer Products VOC
Emissions Inventory Survey (henceforth referred to as "the
survey").9 The survey includes data on VOC content and
product sales quantities for over 7,000 products that fall in
the categories subject to this regulation. The VOC content
data indicate whether the product exceeds the proposed limits.
All products exceeding the limit are assessed the reformula-
tion cost specified for its category in Table 2-1. These
costs are summed across all over-limit products in each
2-11
-------
category to get the survey category total. This was then
inflated to a national estimate using the market coverage
ratio for each category, which indicates the percent of total
market quantity represented by the survey products in that
category.
Table 2-2 presents the results of the reformulation cost
analysis for the proposed regulation. As Table 2-2 indicates,
2,427 products (33.6 percent) from the survey exceed the
proposed limits. The total volume of products that exceed
their regulatory limits is over 930,000 tons, about 31.5
percent of the total volume of surveyed products. The survey
data indicate that a slightly higher proportion of small
products exceeds the limit than large products, as does a
slightly higher proportion of small product volume.
The largest number of products over the limit are found
in the General Purpose Cleaners category, followed by
Insecticides. The category with the highest share of surveyed
products that are over-limit products is Automotive Windshield
Wiper Fluids (83.3 percent). The category with the highest
share of product volume over the limit is Charcoal Lighter
Material (97.9 percent).
The largest reformulation cost impact is found in the Air
Fresheners category (approximately $8.4 million per year)
followed by Insecticides at $4.1 million. Other categories
with annual impacts over $1 million include the following:
Carburetor and Choke Cleaners, Engine Degreasers, Hair Sprays,
Household Adhesives, Laundry Prewash Products, and Glass
Cleaners. Categories with annual costs under $100,000
CSMA indicated that some of the regulated products identified in the
survey may actually represent a group of two or more products with similar
formulations. It was assumed for the purpose of this analysis that the
similarity of these products suggests that a single reformulation effort
would be applicable to all products in the group.10
2-12
-------
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include: Floor Washes/Polishes, Nail Polish Removers, and
Shaving Creams, primarily because there are few products over
the limit in those categories. Note that some of the product
categories with a large number of over-limit products have
relatively low aggregate costs (e.g., General Purpose
Cleaners) because the cost per reformulation is relatively
low. Many of the over-limit general purpose cleaners are
small products with relatively low fixed reformulation cost
per product.
Aggregating across all product types and categories, the
estimated cost of reformulation for all over-limit products
nationally is $25.9 million.
2.4 MARKET ANALYSIS
In this section, market effects of the regulatory action
are analyzed by developing a model of the firm's decision
whether to reformulate or withdraw the product from the
market, followed by a model of how the outcome of this
decision collectively affects aggregate supply conditions and
market outcomes. The model is then operationalized using
baseline market data and regulatory costs to analyze the
welfare effects of these market outcomes.
2.4.1 Potential Firm Responses and Market Effects with
Product Reformulation
In this section, the current assumption that all over-
limit products are reformulated is relaxed to include the
possibility of product withdrawal (exit) if the cost of
reformulating exceeds the net profits generated by the
product. Since the exit option completes the set of producer
options we consider here, this discussion can be viewed as
evolving from a static model of producer impacts
(reformulation only) to a "best-response" criterion for
decisionmaking.
2-14
-------
A simple model of a firm's decision to either reformulate
the over-limit product or exit the market is presented. The
potential for some firms to withdraw products from the market
and for the effect of the variable cost effects to change the
marginal costs for reformulating producers is incorporated
into the discussion of potential market effects.
2.4.2 Exit and Output Decision Model
The firm will weigh the cost of the regulatory response
against the benefits of the action. This equates regulatory-
compliance with the decision to pay the costs and remain in
the market. Thus the benefits of the compliance action are
the net returns (revenues minus costs) obtained from
continuing to produce the product.
The net benefits of compliance for a particular consumer
product exceeding the limit can be expressed in terms of the
net profit it generates:
7TR(q) = P«q - c(q) - r(q) . (2-2)
To ease the notational burden, all terms are expressed in
their annualized form: P is product price, q is annual
output, c(q) is the cost function with respect to annual
output, and r(q) is the annualized cost of reformulation.
If in the market, the producer must decide how much to
produce, assuming that the market for the consumer product is
competitive, the price-taking firm maximizes profits by maxi-
mizing function TIR with respect to its choice of q. This is
indicated by the first-order condition
duR / dq = 0 : P = Bc/dq. + dr/3q. (2-3)
2-15
-------
Here the prof it -maximizing solution equates product price with
marginal production cost (dc/dq) plus any reformulation-
related costs that vary with output (dr/dq) . The latter
reflects the reformulation's variable cost effects referred to
previously. The fixed cost effects, by definition, do not
vary with the level of output and thus are not reflected in
The solution to Equation (2-3) generates (first-order)
optimal output level and profits, qR* and TIR , respectively.
However, the firm will only continue to operate in this market
if it can cover its avoidable costs, that is, if the following
condition is met:
(qR*) ^ 0. (2.4)
If the condition in Equation (2-4) is not met, then the firm's
best response is to withdraw the product, produce no output
(qR* = 0) , and generate zero profits for the product (7TR*=0) .
The absolute change in the output of the regulated
producer can be approximated as follows:
Aq = qR* - q° = (dq/dp) (AP - dr/dq*)
(remains in the market) (2.5)
= - q° (leaves the market)
where (dq/dp) is the firm's usual supply response with respect
to a price change (i.e., the inverse of the marginal
production cost function) and (AP - dr/dq*) is the change in
"net" price for the firm, reflecting a change in the market
*Strictly speaking, fixed reformulation costs can vary with output to
the extent that the output level is what defines a product as either
"small" or "large," for the purposes of the reformulation cost
estimates in Table 2-1. It is more precise to say that marginal
changes in output have no effect on the fixed cost of reformulation.
2-16
-------
price after market adjustments take place less the marginal
compliance cost. Output changes for each producer remaining
in the market depend on whether the price increase (AP)
exceeds the marginal compliance cost (dr/dq, ) . When it does,
as is the case for unconstrained producers or when variable
compliance costs are zero, the output effect is positive.
When the price increase is less than the marginal compliance
cost (e.g., a relatively high per-unit variable cost effect),
the output effect is negative. That is to say if price rises
more than unit costs producers will increase output; if price
rises less than unit costs, they will decrease output.
The change in market price depends on the aggregate
effects of the supply responses of the individual producers.
Product exits will shift the aggregate supply function inward,
and marginal cost effects, such as an increase in material
costs per unit, will shift the function upward. This change
can be expected to raise the post-regulatory market price as
the new equilibrium is attained.
2.4.3 Model Execution and Results
To empirically estimate the effect of VOC content limits
for consumer products, a baseline characterization of affected
markets is constructed, the shifts in market supply and demand
as a result of the regulations are estimated, and a market
equilibrium model is applied to the data to generate changes
in prices and quantities in each market.
Appendix A describes the methodology for incorporating
the reformulation/exit effects into a market model framework.
Appendix A also presents the methodology for measuring the
social welfare effects (e.g., producer and consumer surplus)
of the changes in market equilibrium, which are brought about
by the proposed regulation.
2-17
-------
2.4.3.1 Market Baseline. To analyze market effects, all
products are classified into market segments. Market segments
are clusters of products similar enough to compete with each
other for consumer demand. Because of data limitations,
different products had to be combined to construct individual
market segments.* Although different products within each
market segment may possess different attributes, they perform
similar functions, thereby suggesting a high degree of product
substitutability in demand.
Market segments are defined to correspond with U.S.
Census of Manufactures product codes. Product codes could be
matched with all but three of the product categories. The
categories with no discernible product code correspondence
were Carburetor and Choke Cleaners, Engine Degreasers, and
Fabric Protectants. Thus, market and welfare impacts could
not be directly estimated for these products. However, we
indirectly estimate welfare impacts for these categories
later.
Value of shipments data for the product categories is
presented in Table 1-2 in Section 1. For most categories,
quantity data are not readily available because the Census
does not attempt to add product quantities within a group
whose products may have different units of measure. Because
the market model differentiates between changes in quantity
and price, baseline prices and quantities must be defined. In
lieu of explicit quantity data for the Census categories, the
data are normalized to establish the value of shipments number
as the baseline "quantity"; the baseline quantity then can be
viewed as possessing a baseline "price" of 1.0. This allows
the model to compute changes in prices and quantities. To
*The issue of market definition is presented in most economics texts
that address industrial organization and market structure (e.g..
Reference 11).
2-18
-------
interpret, if the post-equilibrium price is $1.10, this
implies a 10 percent increase in the underlying index of
prices for that category. If the post-equilibrium quantity,
as measured by baseline value of shipments, falls from, say,
1,000 to 950, this suggests a 5 percent reduction in real
output for the products comprising the market segment.
2.4.3.2 Exit Analysis. First product withdrawals are
projected in each market segment. As indicated above, the
withdrawal decision is a function of the cost of the
reformulation and the net value of the profit streams
generated by the products. For each product in the survey
that is over the limit for its category, the annualized
reformulation costs are estimated using the data from Table
2-1. Annualized costs equal the sum of the annualized fixed
costs and annual variable costs. CSMA provided separate cost
estimates for small and large products by category. For the
purpose of projecting exits for an individual product, it
seemed inappropriate to use a single variable cost estimate
for all small or all large products within a category,
regardless of product volume. Therefore, the average variable
reformulation cost per unit was computed for each category and
this number was multiplied by product volume to estimate a
unique variable reformulation cost effect for each over-limit
product in the survey.*
Ideally, CSMA's variable cost estimates would have been reported on
a per-unit basis, rather than a per-product basis. Several
unsuccessful attempts were made in the short time between receipt of
the CSMA data and production of this report to contact CSMA regarding
the product size assumptions they used to generate their variable
cost estimates, so that per-unit cost estimates could be computed.
In lieu of this information, separate estimates of average cost per
unit were initially computed for small and large products by category
by first computing the total variable costs for small (large)
products and then dividing by the total volume of small (large)
products over the limit in each category, respectively. However,
this produced per-unit variable cost estimates for small products
that were sometimes several hundred times the per-unit variable cost
estimates for large products. It was determined unlikely that CSMA
2-19
-------
For each of these products, the annual (gross) profits
generated by the product are estimated as follows:
7tGi:j= Hiij-TRi-j (2-6)
where TRi;jis the total revenue generated by product i in
category j and m- is the gross profit margin, defined as the
ratio of revenues less variable costs to total revenues. TRij
is estimated by taking product i's share of category j's total
sales volume (from the survey), and multiplying this share by
category j's value of shipments (adjusting by the survey
coverage factor).
The profit margin for each product in the survey is
unknown, thus, some reasonable value for m— must be assumed.
For many consumer products, the gross profit margin, i.e., the
gap between product revenue and product variable costs
(materials, labor, energy), may be very high. Gross profits
can be viewed as returns to fixed factors of production, such
as physical capital, intellectual capital (R&D, patents), and
shareholder equity. R&D expenditures in the consumer products
industry are relatively high, due to the frequency of product
introductions and innovations; thus, relatively high gross
profits must be generated to cover these costs.
Using the Investext electronic database,12 financial data
for a few consumer products companies with products affected
by this regulation were obtained. Gross profit margins could
be estimated for two companies. One was a large well-known
multinational company, reporting a 35 to 40 percent margin
between revenues and cost of goods sold (a proxy for gross
intended such a difference in per-unit variable cost effects for
small and large products. Therefore, a single per-unit variable cost
effect was computed and applied to both small and large products
using the method described in the text.
2-20
-------
profits). The other firm was a small biotech/pesticides
company with a gross margin exceeding 70 percent; however, a
majority of product revenue was licensing revenue, with very
low variable costs of production. Since the products of
interest in this study are manufactured products rather than
technology licenses, 70 percent was presumed outside of the
likely gross profit margin range for this study. Therefore,
to cover a "reasonable range" of estimates, the value of mij
was varied from 0.10 to 0.50 throughout the analysis to see
how sensitive the results were to this parameter.
The baseline gross profit estimates are compared with the
projected reformulation costs estimates for each over-limit
product in the survey to determine the number and volume of
product withdrawals. Results are posted in Table 2-3 for
three different scenarios coinciding with three different
assumed values for the profit margin (10, 30, and 50 percent).
Under the lowest profit margin value, 10 percent, the
total projected number of exits from the survey population is
1,369 (20 percent of the products in the survey). These
products, however, account for less than 1 percent of total
product volume. This underscores the fact that the smallest
volume products are the ones most likely to exit because they
generate smaller profit streams to offset the cost of
reformulation. The number and volume of exits decline as the
assumed baseline profit margin for each product rises. There
are only 963 exits (14.0 percent of products, 0.60 percent of
volume) under the 30 percent margin assumption, and only 774
exits (11.3 percent of products, 0.05 percent of volume) under
the 50 percent assumption.
2.4.3.3 Modeling the Regulations' Effect on Market
Supply. The proposed regulation has two potential effects on
the supply of consumer products: (1) a reduction in the number
2-21
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of products on the market and (2) an increase in the cost of
products that remain in the market. The effect of these
factors on market outcomes is depicted in Figure 2-1.
Here the market for a representative consumer product is
characterized by its supply and demand functions. The market
supply function is an aggregation of all producers' supply
functions. Therefore, when producers exit the market, the
supply curve shifts in from S0 to S^ The remaining producers
may be faced with increased variable costs as a result of the
new formulation. This would increase their marginal cost
functions accordingly. Since the individual producer's supply
function is identical to their marginal cost function and the
market supply function is an aggregation of producers' supply
functions, the increase in unit costs translates to an upward
shift in the aggregate supply function to S2. This two-part
shift of the supply function raises the price and lowers the
quantity sold/bought in the new market equilibrium to P2 and
Q2, respectively.
The first part of the supply shift, the inward shift
resulting from product withdrawals, is estimated by
Figure 2-1. Market effects of the proposed regulation.
2-24
-------
quantifying the baseline product quantity removed from the
market rather than reformulated. This quantity was determined
in the previous subsection.
The second part of the supply shift, the upward cost
effect, is quantified using the variable cost shift estimates
in Table 2-1. Recall there are only 15 categories for which
variable cost shifts are indicated. Variable cost effects for
each category were computed as follows
Sj= TVCji/Qj! (2-7)
where TVC^is the total variable reformulation cost for
category j after the exited products are removed (but before
the new equilibrium quantity is reached) and Q^ is category j
quantity after the exited products are removed and before new
equilibrium.
The two supply shifts quantified here are incorporated
into the mathematical market model described in Appendix A and
their effects are thereby translated into the changes in
market prices and quantity and welfare discussed below.
2.4.3.4 Market and Welfare Results. Market model results
are presented in Table 2-4, with a different set of results
corresponding to the three different profit margin assumptions
(10, 30, 50 percent) . Results for the mid-range (30 percent)
scenario are emphasized in this discussion. Please note that
these results do not reflect the effects of the regulation for
the Carburet or /Choke Cleaners, Engine Degreaser, and Fabric
Protectant categories, as baseline market data were
unavailable for these categories. The welfare cost estimates
for the regulation will be adjusted to include those cate-
gories in the section that follows. The price and quantity
2-25
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effects are generally quite small in proportion to baseline
even in the highest cases. Price increases only rise by more
than 1 percent in two markets: Air Fresheners and Automotive
Windshield Washer Fluids. In several markets, the price and
quantity effects are essentially nonexistent.
Producer surplus effects are separated into effects on
the producers of exiting products, effects on producers of
products that remain on the market but must be reformulated,
and effects on the producers that do not exit and need not be
reformulated -- referred to here as the "unconstrained"
producers. A detailed description of how producer (and
consumer) surplus effects are estimated is found in Appendix
A.
For the producers of exiting products, the surplus losses
are limited to forgone baseline profits from those products.
The estimated losses to those producers is about $4.1 million
in the mid-range scenario.
Producers that stay in the market and reformulate bear
reformulation costs but benefit from the post-regulatory price
increase. These two factors have a counteracting effect in
determining the net effect on the reformulating producers. In
the mid-range case, the net cost for reformulating producers
is about $6.4 million; however, the total reformulation costs
across all market categories -- after adjusting for product
exits and changes in output -- is about $13.7 million. Thus,
the positive effect of price increases for the reformulating
producers is about $7.2 million. In some markets (Air
Fresheners, Automotive Windshield Wiper Fluids) the price
benefits exceed the reformulation costs for the reformulating
producers, leading to a net increase in welfare for those
producers. Note that these are both categories with relatively
high projected exit activity in response to the regulation.
2-29
-------
Unconstrained producers unequivocally benefit from the
regulation because they receive higher prices after the
regulation and bear no regulatory costs. The estimated
positive effects for these producers is about $6.1 million in
the mid-range case. Combining these positive effects with the
negative effects for the exiting producers yields a net
producer surplus effect of about -$4.5 million.
Consumers are negatively affected by the increase in
prices caused by the regulation and the consequent reductions
in product consumption. Consumer surplus effects are
approximately -$13.5 million in the mid-range scenario, with
the heaviest effects found in the Air Fresheners market (-$7.9
million), which reflects the proportionately large price and
quantity impacts, and the Insecticides market (-$1.8 million),
which is large relative to the rest of the markets and in the
Air Fresheners market.
Net welfare cost, the sum of producer and consumer
surplus effects, is approximately $18.0 million for the mid-
range scenario.
Sensitivity to the profit margin assumption
It is important not to misinterpret the scenarios
presented here as different regulatory scenarios -- the
regulatory structure is identical in each case. The scenarios
simply reflect the uncertainty surrounding, and sensitivity of
the model to, the proper baseline profit margin assumption. As
the results indicate, the model is quite sensitive to
respecification of the profit margin from 10 percent to 30
percent -- less so when moving from 30 percent to 50 percent.
The price and quantity effects are largest under the 10
2-30
-------
percent assumption and smallest under the 50 percent assump-
tion because the exit-inward shift is greatest in the former
case and lowest in the "latter case. The net welfare effects
rise as the assumed profit margin rises, this despite the
substantial decline in consumer surplus effects from $24.6
million in the 10 percent scenario to $13.5 million and $8.5
million, respectively, in the 30 and 50 percent scenarios.
This decline in consumer surplus losses is more than offset by
an increase in net producer surplus losses. Estimated
producer losses rise as the assumed profit margin rises
because:
1. The forgone profits per exiting product rises,
2. More producers reformulate, and
3. Price effects are smaller.
The rise in forgone profits per exiting product (1) occurs by
assumption, since forgone profits are determined by the
assumed profit margin. Fewer products are projected to exit
in the 30 percent scenario than the 10 percent scenario, but
the exiting producer surplus effects are of similar magnitude
because of the higher forgone profits per unit. With fewer
over-limit products exiting, there are more products bearing
the cost of reformulation (2), and less of an exit-induced
supply shock pushing prices up (3).
Note that under the 10 percent scenario, net producer
surplus effect estimates are actually positive, essentially
reflecting the large transfer from consumers and exiting
producers to the producers remaining in the market. Here,
price effects are largest and reformulation costs are lowest
of all the scenarios, both contributing to net benefits for
the remaining producers.
2-31
-------
2.4.3.5 Variable Cost Savings Paradox: Windshield Wiper
Fluids. The reformulation cost effect provided by CSMA
indicates that for one category, windshield wiper fluids: not
for cold climates, the variable cost of production would fall
after reformulation because of a reduction in material costs.
For a representative small product in this category, the
initial fixed cost of reformulation is estimated at $10,000.
The annual cost savings from the reformulation is estimated at
$5,000. However, most rational producers would make this
rather attractive investment -- one whose initial costs are
recouped in the second year -- without regulatory inducement.
This casts some doubt on the reliability of the
projection that variable costs would actually fall after
reformulation. For comparison, cost and economic impacts are
estimated for the windshield wiper category with the
alternative assumption that the variable cost effects of the
reformulation are zero. The results are presented in
comparison with the estimates under the "variable cost
savings" assumption in Table 2-5. Estimates are provided for
the 30 percent profit margin assumption only. The cost
savings assumption as put forth by CSMA is still the
maintained assumption for the purposes of estimating costs and
economic impacts. The results in Table 2-5 are presented as a
form of sensitivity analysis to that assumption.
Under the "no variable cost effects" assumption for the
"not cold climate" category, the static reformulation cost
estimate (from Table 2-2) rises, but the number and product
volume of exits remain unchanged. The price increase is
somewhat larger when variable cost effects are zero, as is the
quantity reduction. Estimated net welfare effects are
approximately $300,000 higher when the variable cost effect is
assumed zero.
2-32
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TABLE 2-5. WINDSHIELD WIPER FLUID MARKET EFFECTS WITH AND
WITHOUT VARIABLE COST SAVINGS: 30 PERCENT ANALYSIS
With
variable
costs
savings
Static reformulation costs ($000)
Percent of products withdrawn
Percent of quantity withdrawn
Percent change in price
Percent change in quantity
Change in producer surplus ($000)
Exiters
Re formula tors
Unconstrained
Change in consumer surplus ($000)
Net change in total welfare ($000)
Post-reg reformulation costs ($000)
a No variable costs assigned to "Windshield
Climate" category only.
($252
58
6
3
-1
$585
($454
$921
$118
($806
($221
($265
Washer
-74)
.33%
.13%
.29%
.65%
.20
.34)
.36
.17
.33)
-14)
.75)
Fluids:
With
no
variable cost
effect3
$24.
58.
6.
4.
-2.
$488.
($454.
$795.
$147.
($999.
($510.
$24.
Not Cold
10
33%
13%
09%
04%
66
34)
68
32
32)
66)
10
2-33
-------
2.4.3.6 Adjusting Welfare Costs for Categories with
Missing Market Data. Baseline market data could not be
obtained for three of the regulatory categories:
• Carburetor and choke cleaners,
Engine degreasers, and
• Fabric protectants.
This prevented a projection of exits and resulting market
effects for products in those categories. These three
categories account for almost 16 percent of the "static"
estimate of reformulation costs (i.e., not accounting for
exits and market effects)in Table 2-2.
To generate an estimate of total welfare costs of the
regulation that includes the effects for these three
categories, several adjustments to the welfare cost estimates
from Table 2-4 had to be made. The adjusted total welfare
costs are reported in Table 2-6.
First, the static reformulation cost total for the 20
categories included in the market analysis is computed by
summing the annual static cost estimates from Table 2-2 across
those categories. This number is $21.8 million. Then, the
ratio of net welfare costs to static reformulation costs for
the 20 categories where market analysis was performed is
computed for each of the three profit margin scenarios, using
the welfare estimates from Table 2-4. This yields the three
ratios
R(10) = 14,358.29/21,844.94 = 0.657
R(30) = 17,953.26/21,844.94 = 0.822
R(50) = 19,345.93/21,844.94 = 0.886.
Total welfare costs for the three omitted categories can then
be estimated under each scenario by multiplying the static
reformulation costs for the omitted categories by the
respective ratios. These are added to the welfare cost
2-34
-------
estimates from Table 2-4 to produce an estimate of total
welfare costs of the regulation.
As indicated in Table 2-6, the mid-range (30 percent
scenario) estimate of total welfare costs inclusive of all
categories is approximately $21.3 million per year. Estimates
range from $17.0 million under the 10 percent profit margin
scenario to $22.9 million under the 50 percent margin
scenario.
2.5 OUTPUT-RELATED EMPLOYMENT IMPACTS
Regulation-induced reductions in industry output may lead
to corresponding reductions in employment for the consumer
products industry. Employment impacts are estimated by
multiplying the baseline industry employment level (L0) by the
proportional change in industry output from its baseline
level:
AL = (AQ/Q0)»L0. (2-8)
This assumes a fixed relationship between output and
employment, at least for the marginal changes considered here.
Table 2-7 presents the employment impacts results. Total
employment for the seven 4-digit SIC industries covering the
products here (2079, 2841, 2842, 2844, 2879, 2891, 2899) is
198,200 employees. The consumer product sectors covered here
are a subset of this total, so the relevant employment figure
is imputed by first taking the ratio of the value of shipments
of the 20 product categories for which Value of Shipments data
could be obtained (see Table 1-2) to the value of shipments
for all seven 4-digit SIC codes. This ratio was then
multiplied by the employment figure for the seven 4-digit
industries to provide an employment estimate for the products
for the subset of product categories covered by Census data.
2-35
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To account for employment effects for the three product
categories with missing Value of Shipments data (Carburetor
and Choke Cleaners, Engine Degreasers, and Fabric Protect-
ants) , this employment number was then multiplied by the ratio
of total product volume (from the industry emissions survey)
to product volume for all but the three categories.
This produced an estimate of approximately 23,343
employed in the affected consumer products sectors. The
proportional change in consumer products output was computed
by talcing the ratio of the change in output from the market
model (summed across all market segments) over the baseline
output level. This computation was performed for all three
scenarios of the market model.
Given that the output change estimates in the market
model are relatively small, it follows that the estimated
employment impacts are also small. Under the 30 percent
profit margin scenario, there is an estimated loss of
approximately 20 jobs nationwide, a 0.09 percent reduction.
Estimated employment losses are 35 and 12 jobs for the 10
percent and 50 percent profit margin scenarios, respectively.
2 . 6 SUMMARY
The proposed regulations impose a set of standards for
the VOC content of certain consumer product categories.
Products that exceed the limits imposed by these standards
must either be brought into compliance with the limits or be
withdrawn from the market. These compliance actions must be
taken by the producers of the violating products. This leads
to a reallocation of resources toward these efforts, which
imposes opportunity costs directly on the producers and
indirectly on other members of society as producers act,
markets respond, and prices and output change. The purpose of
the preceding section of this report is to characterize the
reallocation of resources and quantify them in dollar-
2-3!
-------
denominated terms to provide an assessment of costs and
economic impacts of the proposed regulations.
Initially, the regulatory impacts are viewed in a very
restrictive light, assuming that reformulation down to the
proposed standards is the only option available to producers.
The aggregate national cost of this restrictive option ($25.9
million) is computed to provide a sense of the empirical
magnitude of the proposed regulations in a very static sense.
The analysis is expanded by shedding the restrictive
assumptions of forced reformulation. If the value of the
benefit stream is less than the cost of compliance, firms will
remove the products from the market as a best-response
strategy. Under this decision rule, approximately 14 percent
of baseline products are projected to exit in the mid-range
scenario, but these products account for less than 1 percent
of total product volume. The range of product exit
projections is 11.3 to 20.0 percent.
The collective effect of some producers removing
unprofitable products and some producers bearing a higher cost
of producing output (due to the reformulation) will contract
the aggregate supply function and lead to changes in market
prices and quantities. The optimal best-response actions and
resulting market outcomes will determine how the welfare costs
of the policy are distributed across producers and consumers.
These factors are incorporated into the market model used in
this ana'lysis.
Using the market model, the estimate of annualized total
welfare cost of the regulation is approximately $21.3 million
(in 1990 dollars), with a range of $17.0 million to $22.9
million. Converting these estimates to 1996 dollars for the
purpose of regulatory analysis, the estimated welfare cost is
$24.3 million, with a range from $19.5 million to $26.2
2-39
-------
million. Estimated welfare effects are all less than one
percent of baseline revenues for the affected product
categories.
The results of the market model suggest that the total
cost of the regulation on consumer products producers is lower
than what is implied by a simple calculation of the cost of
reformulating all baseline products exceeding the regulatory
limits. This is because the best response for many producers
would be to withdraw products from the market and not incur
the reformulation costs. This is projected to be the case for
a number of small-volume products whose relatively small
contributions to firm profits are unlikely to justify the
reformulation investment. Forgone profits of the withdrawn
products contribute to the costs of the regulation. These
forgone profits may overstate opportunity costs, however, as
firms may be able to divert resources used to produce these
products into the production of compliant products. On the
other hand, this may understate costs if the withdrawal of a
noncompliant product imposes other costs not captured by our
model (e.g., cross-product production economies, product/pro-
cess disposal costs, bankruptcy costs).
Several scenarios were modeled for the proposed
standards. In general, market model results indicate
relatively small change in baseline market conditions as a
result of the proposed regulations. This derives from the
empirical expectation that aggregate costs of the regulation
are a small share of aggregate industry costs. However,
The conversion of 1990 dollars to 1996 dollars is computed by
taking the ratio of the 1995 GDP price deflator to the 1990 deflator.
The price deflator for 1990 is 113.3.14 The price deflator for 1995
is projected based on the actual 1994 price deflator (126.1) adjusted
for the average annual rate of inflation indicated in the deflators
from 1990 through 1994. This produced a 1995 deflator projection of
129.5. The ratio of the 1995 to 1990 ratio is then 1.1432, which is
multiplied by the welfare cost estimate in 1990 dollars to derive an
estimate for the welfare costs in (beginning of) 1996 dollars.
2-40
-------
because there is a high degree of producer heterogeneity
within the consumer products sectors, the costs for some
producers may be empirically large. Of particular concern is
the potential impact of the regulations on small producers,
which is the topic of Section 3.
2-41
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SECTION 3
REGULATORY FLEXIBILITY ANALYSIS
Environmental regulations such as the proposed
regulations to reduce the VOC content of selected consumer
products affect both large and small producers of these
products, but small producers may have special problems in
complying with such regulations. The Regulatory Flexibility
Act(RFA) of 1980 requires that special consideration be given
to small entities affected by Federal regulation. Under the
1992 revised EPA guidelines for implementing the RFA, a
regulatory flexibility analysis will be performed for every
rule subject to the Act that will have any economic impact,
however small, on any small entities that are subject to the
rule, however few, even though the EPA may not be legally
required to do so. The analysis in this section addresses
impacts on small entities.
Small entities include small businesses, small
organizations, and small governmental jurisdictions and may be
defined using the criteria prescribed in the RFA or other
criteria identified by EPA. Small businesses are typically
defined using Small Business Association (SBA) general size
standard definitions for Standard Industrial Classification
(SIC) codes. Firms involved in manufacturing the 24 selected
consumer products fall into one of seven 4-digit SIC codes.
The industries include SIC code's 2079 (Edible Fats and Oils,
n.e.c.), 2841 (Soap and Other Detergents), 2842 (Polishes and
3-1
-------
Sanitation Goods), 2844 (Toilet Preparations) , 2879 (Agricul-
tural Chemicals, n.e.c.)/ 2891 (Adhesives and Sealants), and
2899 (Chemical Preparations, n.e.c.). The SBA size standards
for these industries are shown in Table 3-1.
3.1 POTENTIALLY AFFECTED ENTITIES
A regulatory action to reduce VOC emissions from consumer
products will potentially affect the business entities that
own the facilities that produce these products. Facilities,
or establishments, comprise a site of land with plant and
equipment that combine inputs (raw materials, energy, and
labor) to produce outputs (i.e., hair spray, deodorant, etc.).
Firms, or companies, that own these facilities are legal
business entities that have the capacity to conduct business
transactions and make business decisions that affect the
facility. The legal and financial responsibility for
compliance with a regulatory action ultimately rests with
these owners who must bear the financial consequences of their
decisions. Thus, this section focuses on impacts evaluated at
the firm level. Such an analysis involves identifying and
characterizing affected entities; assessing their response
TABLE 3-1. SBA SIZE STANDARDS BY SIC CODE FOR SELECTED
CONSUMER PRODUCTS PRODUCTION INDUSTRIES
SIC code
2079
2841
2842
2844
2879
2891
2899
Description
Edible fats and oils, n.e.c.
Soap and other detergents
Polishes and sanitation goods
Toilet preparations
Agricultural chemicals, n.e.c.
Adhesives and sealants
Chemicals and preparations, n.e.c.
SBA size standard in
number of employees
750
750
500
500
500
500
500
3-2
-------
options by modeling or characterizing the decisionmaking
process, projecting how different parties will respond to a
regulation; and analyzing the consequences of those decisions.
Figure 3-1 illustrates alternative chains of ownership.
The ownership structure may be as simple as one facility owned
by one company or as complex as multiple facilities owned by
subsidiary companies. Potentially affected firms include
entities that supply the consumer products listed in Table
1-2. As indicated in Section 1, affected firms may be
involved in one or more of the following supply stages: (1)
manufacturing, (2) packaging, or (3) distribution.
3.2 ANALYSIS
An analysis of potential small business impacts of the
regulation is presented in this section. Unfortunately, the
product survey data upon which the cost and economic impacts
are estimated in Section 2 do not differentiate between small
and large companies. Therefore, it is impossible to directly
estimate the cost and economic impacts for producers of
different size. As an alternative to direct estimation,
potential small business impacts are analyzed by characteriz-
ing the baseline small business presence in the industries
affected by the regulations. If their presence is signifi-
cant, then regulations affecting this sector will clearly have
important impacts on small businesses unless the magnitude of
the impacts is relatively small or the regulations are
designed to mitigate small business impacts. The cost and
economic impacts modeled in Section 2 are then evaluated in
terms of how they are distributed among market segments with
varying levels of small business presence.
3-3
-------
Parent Company
i
Other Companies
or Legal Entities
I
Subsidiary
Company
(Direct Owner)
I
Facility
Parent Company
Subsidiary
Company
(Direct Owner)
I
Facility
Parent Company
(Direct Owner)
T
Facility
B
Figure 3-1. Chain of ownership.
3-4
-------
3.2.1 Baseline Market Presence of Small Producers
Small business presence in the consumer products industry
prior to the regulation gives one indication of how small
firms may be affected. In characterizing the baseline market
presence of small producers, producers in each of the product
categories were identified, annual sales and employment data
were collected for those companies for which data were
available, and the distribution of firm size was characterized
for each of the product categories with respect to annual
sales figures and with respect to employment figures. The
data on individual product sales volumes, which are reported
in the industry survey conducted by EPA, were also analyzed to
assess baseline presence of small and large products in each
market as a potential indirect measure of small business
effects.
3.2.1.1 Producer Characterization. Producers of the
consumer products included in this analysis were identified
using the Thomas Register Supplier Finder, an electronic
database which provides information on product and service
suppliers in 52,000 product categories. A search was
performed using this directory for each of the 25 product
categories. Efforts were made to identify those companies
owning facilities that produce these products.
During the process of identifying these companies, we
found that some of the product categories were not easily
translated to the product groups identified by the Thomas
Register. Therefore, several adjustments were necessary to
organize the data. The Antiperspirant and Deodorant product
categories were combined into one category. The General
Purpose Cleaners and Dusting Aids product categories were also
combined into one category under which companies were
identified in the Thomas Register as producers of "household
3-5
-------
cleaners." To account for Laundry Prewash manufacturers, a
broader search was performed using "laundry chemicals."
Finally, producers for "five products could not be identified
through the Thomas Register because they are included under
product categories too broad to aid this analysis. These
include Aerosol Cooking Sprays, Carburetor-Choke Cleaner,
Furniture Maintenance Products, Hair Mousse, and Hair Styling
Gels.
Ward's Companies International database was used to
collect annual sales and employment data for the companies
that were selected using the Thomas Register.* Some companies
not found in the Ward's database were located in Dun and
Bradstreet's Million Dollar Directory. The companies for
which sales and/or employment data were found using these two
sources comprise a sample of 220 companies that were used to
perform the small business impact analysis discussed below.
Table 3-2 summarizes the baseline firm-level data by
indicating the number of companies selected from the Thomas
Register and the number of companies in each product category
for which sales and employment data were collected. Because
of the large number of companies engaged in manufacturing some
of the products in this analysis, it was necessary to collect
data on a sample set of the companies.
A significant number of the companies analyzed here
compete in more than one of the 24 consumer product categories
subject to the regulation. Figure 3-2 illustrates the extent
of this horizontal integration across product categories in
the sample group/ Of the 220 companies identified, 34 (15
*The Insecticide and General Adhesives categories were too large to search
for all companies provided by the Thomas Register; therefore, we took
subsets for each.
Including only those companies for which sales and employment data were
available.
3-6
-------
TABLE 3-2. BASELINE MARKET CHARACTERIZATION DATA SOURCES
Firms selected
from Thomas
Product Register
Aerosol cooking sprays
Air freshener
Automotive windshield
washer fluids
Bathroom and tile
cleaners
Carburetor-choke
cleaner
Engine degreasers
Fabric protectants
Floor polishes/waxes
Furniture maintenance
products
General purpose
cleaners/dusting aids
Glass cleaners
Hairsprays
Hair mousses
Hair styling gels
Household adhesives
Insecticides
Laundry prewash
Laundry starch products
Nail polish removers
Oven cleaners
Shaving creams
Antiperspirants/
deodorants
Charcoal lighter
material
NA
40
37
42
NA
64
13
101
NA
110
111
16
NA
NA
94
120
35
9
5
17
19
144
9
Firms with
sales
data
collected
NA
20
14
10
NA
21
7
31
NA
37
36
10
NA
NA
30
35
9
5
2
7
9
46
4
Firms with
employment data
collected
NA
20
14
11
NA
22
7
31
NA
38
36
11
NA
NA
30
36
9
6
2
7
10
48
4
NA = Not available.
3-7
-------
Firms Producing
7 Products
2
(1%)
firms Producing
6 Products
2
(1%) ^^^^^^^^^^^^^^_ Firms Producing
^^^^^^^^^^^^^^^ 1 Product
160
(72.7%)
Rrms Producing
4 Products
9
(4%)
Firms Producing
3 Products
12
(5%)
Rrms Producing
2 Products
35
(15.9%)
Figure 3-2. Horizontal integration within
23 product categories.
percent) compete in two product categories, 12 (5 percent)
compete in three categories, 8 (4 percent) compete in four, 2
(1 percent) compete in six, and 2 compete in all seven product
categories.
3.2.1.2 Small Business Market Presence: Characterized by
Sales. Table 3-3 characterizes the distribution of firm size
for each product category with regard to 1994 annual sales
data. Each firm is assigned to one of four annual sales
cohorts: less than $25 million, between $25 million and $100
million, between $100 million and $1 billion, and greater than
$1 billion. Table 3-3 also provides the percentage of total
sales represented by each sales cohort for a given product
category. Please note that the sales figures correspond with
all sales for the respective categories, not just those
derived from consumer product sales.
As Figure 3-3 illustrates, the majority (63.2 percent) of
the 220 firms in this analysis have annual sales figures below
$25 million. Firms with annual sales greater than $1 billion
comprise 10.9 percent of the sample, while firms with sales
3-1
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Greater than $1 Billion
10.9%
(24)
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andSIB
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^^^^^^_ MT1
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63.2%
(139)
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and $100 MM
18.2%
(40)
100% = 220 firms
Figure 3-3. Distribution of firms by size:
characterized by annual sales.
between $25 million and $100 million represent 18.2 percent of
the total and firms with annual sales between $100 million and
$1 billion represent 7.7 percent of the sample.
Product categories with proportionately high numbers of
firms with sales under $25 million include automotive
windshield washer fluids, bathroom and tile cleaners, engine
degreasers, and oven cleaners. Bathroom and tile cleaners
also report a large share of revenue accounted for by the
smallest companies. The lowest sales value companies have
relatively little presence in the laundry products categories.
While the majority of firms in this analysis are small,
the large firms are responsible for the vast majority of total
sales, as illustrated in Figure 3-4. As shown, 93.5 percent
of the total sales of the 220 firms in this analysis are
attributed to those firms with annual sales of $1 billion or
greater, while firms with annual sales of less than $25
million represent only 0.8 percent of total sales.
3-11
-------
Greater than
$1 Billion
93.5%
Between $tOO MM and $1 B
Between $25 MM and $10 MM
5.4%
Less than fes MM
0.8%
100% « $148.4 billion in sales
Figure 3-4. Distribution of total sales by firm size.
3.2.1.3 Small Business Market Presence: Characterized by
Number of Employees. Table 3-4 characterizes the distribution
of firm size in each product category as defined by the SBA
size standards illustrated in Table 3-1. The size cutoff
between large and small firms is 500 employees for all product
categories with the exception of General -Pxirpose Cleaners and
Laundry Prewash product categories, with each having a cutoff
of 750 employees.
Figure 3-5 illustrates the distribution of the 220 sample
firms by number of employees. Using a 500 employee cutoff,
78.6 percent of the firms are defined as small firms; however,
these 173 firms represent only 2.5 percent of the total number
of employees in the analysis (Figure 3-6) and 2 percent of
total sales (Figure 3-7).
In some product categories, all firms for which data were
collected are classified as small by the SBA standards
(Bathroom and Tile Cleaners, Nail Polish Removers) and for
many other categories, the small firm share is over 90
percent. The product categories with the smallest shares of
small firms include the two laundry categories, Fabric
3-12
-------
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3-13
-------
Small Firms
78.6%
(173)
Large Firms
21.4%
(47)
100% = 220 firms
Figure 3-5. Distribution of firms by size:
characterized by number of employees.
Large Firms
97.5%
Small Firms
2.5%
100% = 707,302 employees
Figure 3-6. Distribution of employees by firm size.
Large Firms
98%
Small Firms
2%
100% = $148.4 billion in sales
Figure 3-7. Distribution of sales by firm size:
defined by number of employees.
3-14
-------
Protectants, Air Fresheners, and Shaving Creams.
3.2.1.4 Small Business Market Presence: Characterized by
Product Size. EPA surveyed producers of consumer products to
inventory VOC emissions from this category. In addition to
VOC content, the survey also provided information on the
annual (1990) sales volume (tons) for each product. Table 3-5
reports market concentration measures for each product
category. This indicates the degree to which production is
dominated by the largest 8/4/1 products in each category. The
8/4/1 product concentration measures are reported in Table 3-
5. In almost all cases, the 8-product-concentration measure
exceeds 80 percent and the 4 -product concentration measures
exceed 60 percent. In two cases (Dusting Aids /Furniture
Maintenance and Charcoal Lighter Material) the largest product
accounts for over one-half the total category volume. General
Purpose Cleaners, Hair Styling Gels, Household Adhesives, and
Pesticides all have 8-product concentration measures in the
20- to 40-percent range, indicating relatively unconcentrated
production in those categories.
A more comprehensive measure of market concentration that
is frequently used in analyses of industry market structure is
the Herfindahl Index,15 which is computed as the sum of squares
of the market share for each of the M.^ products in market i :
HI, - S0>
where Si:j is the share of product j in market i. Since Si;j is
always between 0 and 1, and sums to 1 across all products in
the market, then HIj is also between 0 and 1, with 1
indicating a pure monopoly (one producer) and a number close
to 0 indicating highly unconcentrated production (perfect
competition) .
3-15
-------
TABLE 3-5. PRODUCT-LEVEL CONCENTRATION MEASURES
Product
Aerosol cooking
sprays
Air freshener
Automotive
windshield washer
fluids
Bathroom and tile
cleaners
Carburetor-choke
cleaner
Dusting
aids / furniture
maintenance products
Engine degreasers
Fabric protectants
Floor polishes/waxes
General purpose
cleaners
Glass cleaners
Hairsprays
Hair mousses
Hair styling gels
Household adhesives
Insecticides
Laundry prewash
Laundry starch
products
Nail polish removers
Oven cleaners
Shaving creams
Antiperspirants/
deodorants
Charcoal lighter
material
Percent
category
volume by
largest 8
products
84.56%
77.07%
82.14%
81.26%
70.38%
83.67%
76.03%
89.88%
60.74%
36.46%
83.75%
62.55%
77.00%
37.26%
26.82%
35.26%
93.53%
91.28%
73.78%
81.86%
98.87%
86.52%
99.12%
Percent
category
volume by
largest 4
products
66.83%
61.39%
68.18%
69.82%
61.81%
75.60%
65.86%
79.36%
45.22%
24.87%
78.80%
49.51%
54.50%
20.81%
17.63%
22.84%
75.46%
78.85%
50.56%
71.30%
85.21%
56.21%
96.39%
Percent
category
volume by
largest
product
33.29%
29.04%
26.54%
40.64%
24.26%
61.11%
46.21%
48.46%
20.61%
8.93%
56.06%
21.24%
30.41%
5.57%
8.74%
8.17%
29.80%
29.47%
16.66%
27.46%
28.42%
16.50%
55.02%
Product
level
Herf indahl
Index
0.1613
0.1311
0.1362
0.2063
0.1146
0.3831
0.2324
0.2706
0.0769
0.0263
0.3344
0.0920
0.1287
0.0297
0.0184
0.0236
0.1819
0.1821
0.0881
0.1590
0.2014
0.1085
0.3729
3-16
-------
That Herfindahl measures in Table 3-5 are all less than
0.50 and generally less than 0.20. The index values suggest
that Dusting Aids/Furniture Maintenance and Charcoal Lighter
Material are the most concentrated markets (Hefindahl values
near 0.40), while Household Adhesives and Insecticides are the
least concentrated (Herfindahl values close to zero).
The data in general suggest that most categories have a
few large products and many small products. Thus, to the
extent that regulatory effects are widespread in each
category, regulatory impacts are likely to frequently fall on
producers of products that have relatively small market shares
in their respective categories.
3.3 IMPACTS ANALYSIS
Table 3-6 provides a synopsis of the impacts modeled in
Section 2 alongside the large/small distribution measures
presented in this section to illustrate the relative impact
on categories with relatively small producers. The focus of
this discussion will be on the mid-range impacts (model
results assuming a 30-percent profit margin).
The category with the highest rate of product exit is
automotive Windshield Wiper Fluids, with over 6 percent of
baseline quantity projected to be withdrawn. The only other
category with more than I percent of baseline quantity
withdrawn is Air Fresheners. Of these two categories, only
Windshield Wiper Fluids appears to have a relatively large
small business presence relative to the rest of the product
categories, with 93 percent of the firms in this industry
classified as small subject to the Small Business
Administration definition. It is also one of the few
categories with no firms having total sales revenue over $1
billion.
3-1'
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-------
As explained in Section 2, however, the fact that there
is a high exit rate from one market does not mean that
producers are hurt overall. The high exit rates from the Air
Fresheners and Automotive Windshield Wiper Fluid markets leads
to more significant inward shifts in product supply, higher
price increases, and greater benefits accruing to those
products remaining in the market. Thus, the net effect on
producers in these markets is actually positive, as the
positive price effects exceed the losses due to exit and
reformulation cost. In sum, we have a set of transfers from a
relatively large set of small product producers (and
consumers) to the producers, large and small, that remain in
the market.
Table 3-6 lists the producer surplus effects for the
model scenarios in Section 2, both in absolute terms and as a
percentage of baseline revenues for the category (where
possible to compute). The largest absolute producer surplus
effects are found in the Insecticides market, but the largest
losses in proportion to baseline revenues (4.8 percent) are
found in the Laundry Prewash product market. In these
markets, relatively little baseline production is withdrawn
from the market and most producers bear the reformulation
costs with little offset in the way of price increases.
About half of the firms producing Laundry Prewash items
are considered large, both by SBA standards and by virtue of
the fact that their sales revenues exceed $1 billion. Thus,
the fact that producer surplus effects are proportionately
largest in this category does not, by itself, provide evidence
of disproportionate small business impacts.
The category with the next largest (negative) producer
impact relative to baseline revenues is Charcoal Lighter
Material (-2.0 percent). Also, nearly all of baseline
3-21
-------
production volume is initially over the content limit and
subject to reformulation or exit. Few products are projected
to exit. Seventy-five percent of the identified companies in
this group are considered small by SBA standards and no
company has sales exceeding $1 billion. Within the group,
however, production is highly concentrated in a few products
(Herfindahl index - .3729) .
One category with all measures indicating substantial
small business presence is Nail Polish Removers. All of the
firms identified as producers of Nail Polish Removers are
defined as small by SBA standards. The Herfindahl Index value
indicates relatively low concentration for this category as
well (.0881). The content limits affect only one-quarter of
Nail Polish Removers baseline product volume and very little
exit activity is projected. Producer surplus losses for this
group are about 1 percent of baseline revenue. These factors
combine to suggest that perhaps the category with the greatest
small business presence does not suffer impacts that are out
of proportion to the rest of the categories.
3.4 SUMMARY
The purpose of this section is to assess the impacts of
the regulation on small businesses in the regulated
industries. Data limitations prevented direct attribution of
cost and economic impacts (from Section 2) to producers of
different size. In lieu of direct estimation, one measure of
potential impacts is the baseline presence of small companies
in the regulated industry. Any regulation applied broadly to
an industry is likely to have small business impacts if that
industry has a significant small business presence. The
regulations considered here are broad-based in that they apply
to all products sold in a wide range of consumer product
categories.
3-22
-------
As the data in this section indicate, many of the
producers of these products can be classified as small by
various definitions of 'the term. Most categories have a
relatively few number of larger producers accounting for most
of the product volume, but these producers are flanked by a
large number of small producers. Therefore, any regulation
broadly applied to this sector is likely to have some negative
impact on small businesses. Given this as a baseline
condition, a question remains whether the regulation, as
currently designed, has a disproportionate impact on small
producers.
One negative impact to consider is the withdrawal of
products from the market in lieu of regulatory compliance.
Producers will remove products from the market, rather than
comply with the regulation, if the profit streams from that
product cannot justify the cost of reformulating it to comply
with the regulation. Exit is a more likely option for small
products, all else equal, because the relatively small profit
streams are less likely to justify a reformulation that often
has a large component of fixed costs. The economic models
employed in this study indicate that a sizable number of
baseline products are projected for removal (10 to 20
percent), but that these are very small volume products and
have very little effect on overall market quantity (<1
percent). It is impossible in this analysis, however, to
determine how small product exits correspond with small
company impacts, since small products may be made by large
companies and vice versa.
One indication of potentially disproportionate impacts on
small business would be a finding that, within the industry,
the impact of the regulations falls most heavily in product
categories with the largest small business presence. This
does not appear to be the case with the consumer products
3-23
-------
regulation. The markets most negatively affected by the
consumer products regulation are not the markets with the
greatest small business presence. Conversely, the market with
the greatest small business presence is not projected to be a
disproportionately large loser under these regulations.
In conclusion, 'the proposed regulations will have some
impact on small producers by virtue of the fact that they have
a significant presence in some of the regulated industries and
may be likely to experience high rates of product exits.
However, the regulations do not appear more or less stringent
for categories with clearly defined small business presence.
The potential effect on small businesses is somewhat mitigated
by the fact that overall costs are a relatively small share of
total industry revenues.
3-24
-------
SECTION 4
REFERENCES
1. Stigliani, William M. Chemical Emissions from the
Processing and Use of Materials: The Need for an In-
tegrated Emissions Accounting System. Ecological
Economics 2(4) :325-341. 1990. (Adapted from Figure 2.)
2. U.S. Environmental Protection Agency. Study of Volatile
Organic Compound Emissions from Consumer and Commercial
Products: Report to Congress. Office of Air Quality
Planning and Standards. Research Triangle Park, NC.
EPA-453/R-94-006-A. March 1995.
3. Reference 2.
4. Telecon with Cosmetic Toiletries and Fragrance Associ-
ation. June 9, 1995. Murray, Brian, RTI, Harrison, Rob,
Radian Corporation. Moore, Bruce, US EPA.
5. Radian Corporation. Volatile Organic Compounds Emissions
from Consumer and Commercial Products Underarm Deodorants
and Antiperspirants. Prepared for U.S. Environmental
Protection Agency, QAQPS. December 1991.
6. Telecon. Epperson, David, Radian Corporation, with
Murray, Brian, RTI. July 7, 1995. Survey database
protocol.
7. Reference 5.
8. U.S. Department of Commerce. 1995. Implicit Price
Deflators for Gross Domestic Product, 1959-1994.
9. U.S. Environmental Protection Agency. VOC Emissions
Survey for Consumer and Commercial Products. Office of
Air Quality Planning and Standards. 1993.
10. Personal communication. Letter from Fratz, D. Douglas,
Chemical Specialties Manufacturers Association to
Madariaga, Bruce, U.S. Environmental Protection Agency,
Office of Air Quality Planning and Standards, July 20,
1995.
4-1
-------
11. Viscusi, W. Kip, John M. Vernon, and Joseph E.
Harrington, Jr. Economics of Regulation and Antitrust.
Lexington, MA, D.C. Heath and Company. 1992.
12. Infotrac. Investext. Foster City, CA: Information
Access Company.
13. U.S. Department of Commerce. 1992 Census of
Manufactures: Statistics for Industry Groups and
Industries. Washington, DC, U.S. Government Printing
Office. 1992.
14. Reference 8.
15. Tirole, Jean. The Theory of Industrial Organization.
MIT Press. 1988
4-2
-------
APPENDIX A
MARKET MODEL METHODOLOGY
The methodology for estimating the aggregate market-level
effects of the consumer products regulation is now considered.
The model incorporates the responses of affected producers and
consumers. First we focus on the affected producers.
A.I SUPPLY EFFECTS
For the purposes of modeling the regulatory effects in
each market, producers are separated into three categories
based on their response to the regulation:
• producers of products slated for withdrawal,
• producers of products slated for reformulation, and
• producers of unconstrained products (i.e., VOC content
below the regulatory limit).
The baseline (preregulatory) quantities from these groups
are denoted as follows: Qx, QR, and Qu for Groups one, two, and
three, respectively. Total baseline market output equals the
sum of the three components:
Q = Qx + QR + Qu. (A-l)
Figure 2-1 in Section 2 depicts the aggregation of these
subgroups into a market supply function. The regulation
A-i
-------
causes a shift in the aggregate supply function depicted in
Figure 2-1 because of two phenomena: an inward supply shift
due to eliminating Group 1 through product withdrawals (e.g.,
the shift from S0 to Sx) , and an upward supply shift due to
variable cost effects on the products from Group 2 (the shift
from Sx to S2) . There is no supply shift emanating from Group
3 because the unconstrained producers experience no
regulation- induced change in their cost structure. So the
full regulation-related shift is from S0 to S2, which leads to
a new market equilibrium. At the new equilibrium, price rises
to P2 and quantity falls to Q2 .
A. 2 COMPUTING CHANGES IN EQUILIBRIUM PRICES AND QUANTITIES
The change in equilibrium prices and quantities for the
products affected by the content limits can be numerically
computed by adjusting the equations in the supply and demand
system to reflect the imposition of these limits. For each
market, i, the equilibrium change in quantity supplied of each
product affected by the regulations equals the sum of the
supply changes from each of the producer subgroups :
(A-2)
The change (from baseline) in quantity supplied by
producers withdrawing their products is simply the negative of
the quantity originally supplied by that group:
(A- 3)
The change in quantity supplied from the reformulating
producers is specified as follows:
(A-4)
A-2
-------
where eiR is the supply elasticity of the reformulating
producers in market i, /\P± is the change in equilibrium market
price, C^ is the per-unit variable cost effects of the
reformulation, and other terms are as previously defined
(without the subscripts) . AP^ Ci is the change in "net price"
for the producers who face variable reformulation costs (i.e.,
the change in unit price less the change in unit cost) .
The change in quantity supplied from the unconstrained
group is
AQiU = eiu(Qiu/P)APi. (A-5)
These producers respond to the increase in price with no
counteracting effect on their cost structure. Given a
positively sloped supply function (i.e., a positive supply
elasticity) the higher price in the post-regulatory
equilibrium, output will increase from this group of
producers. It is important to note that the quantity response
for reformulating products whose variable costs are not
affected by the reformulation (Ci=0) is analogous to the
response for unconstrained products since the marginal cost
conditions for the reformulating products have not changed.
The aggregate change in equilibrium supply quantity can
now be restated by combining the preceding four equations :
The change in market demand for each product is given by
AQiD = E(Q/P)^P (A-6)
A-3
-------
where Ei:L is the own-price demand elasticity for product i. To
attain equilibrium, the change in quantity demanded must equal
the change in quantity "supplied in both markets:
AQiD = AQi5. (A-7)
This provides a system of M»3 equations in M»3 unknowns,
where M equals the number of markets affected by the
regulation. This can be reduced to an M»2 equation system,
simply by substituting AQiD=AQis=AQi. This system can be
solved simultaneously to compute the change in equilibrium
price and change in equilibrium quantity for each market. To
do this requires baseline market data, an empirical
characterization of the various supply shocks alluded to
above, and model parameters (supply and demand elasticities).
The baseline data and empirical market shocks are presented in
the main text. Model parameter selection is discussed below.
A.3 SUPPLY AND DEMAND PARAMETERS
Economic theory posits that own-price supply responses
are positive (producers produce more at higher prices) and
own-price demand responses are negative (consumers consume
less at higher prices) . While this sets some guidelines for
parameter values, realistic magnitudes must be established for
these parameters for the commodities of interest. Alternative
approaches for accomplishing this on a market-specific basis
include:
• use current estimates from the literature,
• perform econometric estimation, and
• use "ballpark" estimates from similar commodities.
Because of the wide variety of products considered in
this regulation, all three approaches were used to derive
parameter estimates for each of the market segments in this
study. The parameter estimates are listed in Table A-l.
Procedures for each approach are discussed in turn below.
A-4
-------
TABLE A-l. PARAMETER ESTIMATES USED IN MARKET MODEL
Market segment
Aerosol cooking sprays
Air freshener
Automotive WWF
Bathroom and tile cleaners
Carburetor and choke cleaners
Dusting aids /furniture maintenance products
Engine degreasers
Fabric protectants
Floor polishes /waxes
General purpose cleaners
Glass cleaners
Hair sprays
Hair mousses
Hair styling gels
Household adhesives
Insecticides
Laundry prewash
Laundry starch products
Nail polish removers
Oven cleaners
Shaving creams
Ant iper spirants /deodorants
Charcoal lighter material
Supply
elasticity
1.00a
1.00s
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.59b
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
1.00a
Demand
elasticity
-0.50C
-0.50C
-0.50C
-0.50C
-0.50C
-0.50C
-0.50C
-0.50°
-0.50C
-0.50C
-0.50C
-0.50°
-0.50C
-0.50°
-0.50°
-0.33d
-0.50C
-0.50°
-0.50°
-0.50C
-0.50°
-0.50C
-0.50C
a Ballpark estimate from "typical" empirical estimates.
Based on three-staged least-squares estimation of supply function
for Adhesives.
Based on three-staged least-squares estimation of demand function
for Adhesives.
° From insecticide demand elasticity estimates in US Environmental
Protection Agency. Economic Impact Analysis of Proposed Effluent
Guidelines and Standards for the Pesticide Manufacturing Industry
USEPA, Office of Water, Office of Science and Technology. March
1992.
A-5
-------
A. 3.1 Estimates from the literature
Under the time and resource constraints imposed by the
proposed regulatory schedule, the use of previously derived
parameter estimates is an attractive alternative. A review of
the literature, however, revealed few demand elasticity
estimates and no supply elasticity estimates for the specific
product markets subject to the regulation. A demand
elasticity for insecticides gleaned from an economic impact
analysis of effluent guidelines for the pesticides industry1
was used in the analysis.
A. 3. 2 Econometric Estimation
In lieu of estimates from the literature, an attempt was
made to directly estimate supply and demand elasticities using
an econometric approach. This requires specifying
theoretically consistent supply and demand equations,
collecting data on the dependent and independent variables,
and applying econometric methods to the data to derive the
estimates .
The demand for a specific consumer product is
hypothesized to be a double-log function of its own price,
consumer income (Y^and Population (Popi)
LnfQi) = Eoi + E^LnCP^ + E^LnlY^ + E^LnlPopi). (A-8)
Because of the double-log specification, Eii gives the
proportional change in quantity demanded with respect to a
proportional change in price, i.e., the demand elasticity
referred to above.
The supply of consumer product i is hypothesized to be a
function of its own price (P^ and the price of variable
inputs: labor (WLi) , and materials (Wj^) .
-------
Ln(Qi) = eoi + eiiLn(Pi) + eLiLn(Wu) + e^LnfW^) (A-9)
with ei:L representing the own-price supply elasticity.
The econometric procedure involves performing three-
staged least-squares (3SLS) estimation of the supply/demand
system for each product. 3SLS is a simultaneous equations
approaches that controls for the joint operation of supply and
demand forces generating the equilibrium prices and quantities
while allowing for separate identification of supply and
demand effects.2
Operationalizing the model requires observations on the
data for all of the variables defined above. Because multiple
observations are needed, time series data are necessary to
perform the estimations for any market segment. This presents
several problems. First, the data on the variables necessary
to estimate the supply/demand system are generally not
available for the specific products subject to the regulation.
The primary problem is that data are generally available on
labor wages and material costs at higher levels of aggregation
(4-digit SIC codes, U.S. Census classification scheme) than
those for the consumer products specified here (primarily 5-
and 6-digit SIC codes). However, even at the 4-digit SIC
level—there is a total of seven 4-digit categories for the 23
market categories—there is little time series data available
and what is available has may have frequent gaps for key
variables.
Because of these data problems, econometric estimation
was performed for only one category (household adhesives),
based on a complete set of data for SIC 2891, General
Adhesives and Sealants, from 1985-1993.3 Unfortunely, these
data provide only nine annual observations from which to
estimate the system, which makes statistical inference more
difficult. Data on U.S. Gross National Product (U.S. Bureau
of Economic Analysis) and U.S. Population (U.S. Bureau of the
A-7
-------
Census) for 1985-1993 were used for the demand variables:
income and population.
The 3SLS regression generated a demand elasticity
estimate of -0.52 and a supply elasticity estimate of +1.59.
Neither value was statistically significant at the 5 percent
level (t-statistics of -0.526 and +0.530, respectively), which
is not surprising given the small number of observations used
in the estimation. Several different specifications were
attempted for the system, but none produced superior results.
Faced with the choice between using statistically insignifi-
cant parameter estimates or some ad hoc estimates, the former
option was chosen under the rationale that these estimates
have at least some foundation in the data representing the
markets of interest. Moreover, the results seem "reasonable"
in the context of short-run demand and supply parameter
estimates typically published in the literature. Because of
the statistical weakness of the results, the precision of the
analysis results may suffer; however, there is no statistical
or theoretical reason to believe that the estimates are biased
in one direction or the other.
A.3.3 "Ballpark" Estimation
For most market categories, neither estimates from the
literature nor direct estimation was feasible for providing
supply/demand parameter estimates. Thus, for all categories
except Adhesives, the supply elasticity was set to unitary
(1.0), indicating an assumed equiproportional response in
quantity supplied to a change in the market price. This is
within the range of estimates often found for short-run supply
elasticities in empirical work and does not vary much with the
single estimate derived here for Adhesives.
The demand elasticities were all set to the demand
elasticity estimated for Adhesives (-0.50) except for the
extraneous estimates provided for Insecticides and Aerosol
A-8
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Cooking Sprays referenced above. The rationale behind using
the Adhesives estimate for all other categories without an
extraneous estimate is that the relatively inelastic response
for adhesives seemed reasonable for most of the other product
categories as well.
A.4 COMPUTING WELFARE EFFECTS
Changes in the market equilibrium cause changes in
resource allocation, which, when quantified, provide measures
of how the welfare costs of the regulation are distributed
across groups affected by the regulation. The groups we focus
in the welfare analysis are consumer products producers and
consumers because the changes in prices and quantities
directly affect their welfare. In this study we do not
measure the welfare benefits of reductions in VOC emissions, a
value against which these costs may be measured to determine
the net value to society of the proposed regulatory structure.
A.4.1 Effects on Consumer Products Producers
We can compare the profits earned at the new equilibrium
to the profits earned at the old equilibrium as a measure of
effects of the regulation on the individual producer. Forgone
baseline profits (nG) provide a measure of the loss to
producers that choose to exit rather than reformulate:
An = nR* - nG = -nG. (A-10)
For the remaining producers, the change in profits is affected
by several factors, including the incurrence of the fixed
reformulation cost and any associated changes in price,
quantity, and marginal cost.
A-9
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The remaining firms' costs may be affected by
reformulation. The effect of the content limit on producers
is generally not uniform and thus raises some distributional
considerations. As indicated above, the expected shifts in
the aggregate supply function will cause the market price to
rise. For some producers, the benefits of the price increase
may outweigh the net costs of compliance. This is certainly
the case for producers of consumer products with VOC content
below the regulatory standards, because they incur no
reformulation costs but would gain from the rise in market
price sparked by the compliance costs and/ or product
withdrawals incurred by their competitors. Alternatively,
fixed reformulation costs may be substantial for some
producers, outweighing any positive price effect. The net
profit effect will be negative for those producers. Other
producers may fall in the midrange, where the price benefits
and cost effects essentially offset each other.
Changes in producer welfare are generally reported as
changes in producer surplus. The aggregate change in producer
surplus for the withdrawn-product producers equals the sum of
forgone profits from all withdrawn products in market i:
APS.X = E n-j • (A-11)
The j subscript indicates forgone profits from the j ' th
product in market i and N.* is the number of products exiting
market i .
The change in producer surplus from the reformulating
sector can be approximated as follows :
A-10
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TECHNICAL REPORT DATA
(Please read Instructions on reverse before completing)
1. REPORT NO
EPA-453/R-96-014
3 RECIPIENT'S ACCESSION NO
4 TITLE AND SUBTITLE
Economic Impact and Regulatory Flexibility Analysis of the
Regulation of VOCs from Consumer Products
5. REPORT DATE
October 1996
6 PERFORMING ORGANIZATION CODE
7 AUTHOR(S)
Lisa Conner, Innovative Strategies and Economics Group
8 PERFORMING ORGANIZATION REPORT NO
9 PERFORMING ORGANIZATION NAME AND ADDRESS
10 PROGRAM ELEMENT NO
U.S. Environmental Protection Agency
Office of Air Quality Planning and Standards
Air Quality Strategies and Standards Division (MD-15)
Research Triangle Park, NC 27711
11 CONTRACT/GRANT NO
12 SPONSORING AGENCY NAME AND ADDRESS
John Sietz, Director
Office of Air Quality Planning and Standards
Office of Air and Radiation
U.S. Environmental Protection Agency
Research Triangle Park, NC 27711
13. TYPE OF REPORT AND PERIOD COVERED
14 SPONSORING AGENCY CODE
EPA/200/04
15 SUPPLEMENTARY NOTES
16 ABSTRACT
This report evaluates the impacts of the final rule for controls of volatile organic compounds (VOC) in 25
markets for consumer products. Total social costs are estimated by evaluating costs of compliance with
the rule and associated market impacts, including: price changes for 25 market segments, adjustments in
quantity produced, small entity impacts, and employment losses.
17. KEY WORDS AND DOCUMENT ANALYSIS
a DESCRIPTORS
economic impacts
small entity impacts
social cost
18. DISTRIBUTION STATEMENT
Release Unlimited
b IDENTIFIERS/OPEN ENDED TERMS
Air Pollution control
Economic Impact Analysis
Regulatory Flexibility Analysis
19. SECURITY CLASS (Report)
Unclassified
20. SECURITY CLASS (Page)
Unclassified
c. COSATI Field/Group
21. NO OF PAGES
22. PRICE
EPA Form 2220-1 (Rev. 4-77) PREVIOUS EDITION IS OBSOLETE
-------
N,"
APS.* = (APi - C±) -Q.R + 0.5-AQ.*- (AP. - C.) - *:
1 1 x- x 1
(A-12)
APi is the change in equilibrium price, AQ^ is the change in
equilibrium quantity from the reformulating producers, QiR is
the initial quantity of the reformulating producers, c^ is the
average per-unit variable reformulation costs for reformulat-
ing products in market i, and r^ is the annualized fixed
reformulation costs for over-limit product j in market I and
N* is the number of products to be reformulated in market I.
The whole producer surplus term in Equation (A-12) reflects
producer benefits in the form of price increases along with
consumer costs in the form of variable (Ci) and fixed (ri;j)
reformulation costs.
Finally, the change in producer surplus for producers not
facing compliance costs is
with the Q^ reflecting the quantity supplied by these
unconstrained producers. Total (net) producer surplus effects
are simply the sum of the terms above:
(A-14)
A.4.2 Effects on Consumer Products Consumers
Changes in consumer welfare are measured by the change in
consumer surplus, which quantifies losses due to a combination
of the higher price and reduced consumption quantity. This
change can be approximated as follows:
ACSi = -APi»Qi + 0.5»APi'AQi. (A-15)
A-ll
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where Q.^ (Aq.^) is the baseline quantity (change) in market i.
A.4.3 Net Welfare Effects
We computed the net welfare effects by taking the sum of
producer and consumer surplus effects:
AWFi = APSi + ACSi- (A-16)
This calculation nets out any transfers from one group to
another within society (e.g., transfers from consumers to
producers through higher prices) because these transfers do
not affect the total sum of resource costs, just how they are
distributed within society. AWFi provides an estimate of the
net social costs of the regulation. This includes the cost of
reformulation, borne partly by consumers in the form of higher
prices and "deadweight" losses to consumers and producers
reflecting reductions in market output.
A-5. REFERENCES
1. U.S. Environmental Protection Agency. Economic Impact
Analysis of Proposed Effluent Guidelines and Standards
for the Pesticides Manufacturing Industry. USEPA, Office
of Water, Office of Science and Technology. March 1992.
2. Pindyck, Robert S., and Daniel L. Rubinfeld. Econometric
Models and Forecasts. McGraw-Hill, New York. 1981.
3. U.S. Department of Commerce, Bureau of Census, Annual
Survey of Manufacturers.
A-12
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