Question

What is a marketable permit and what incentive does it provide for a firm to account for external costs?

Short answer

A marketable permit is a government-enforced policy that sets a limit on pollution or negative externalities and allows firms to trade these permits. It creates a flexible "cap and trade" system, incentivizing firms to reduce pollution and account for external costs. Firms that efficiently reduce emissions can profit by selling excess permits, while others can purchase permits to continue operating without disruptions. This promotes innovation and investment in cleaner technologies, ultimately achieving government-established environmental targets.

Step-by-step solution

Define Marketable Permit

A marketable permit is a mandatory government policy that sets a limit on the total amount of pollution or other negative externalities that a firm can produce and allows firms to buy, sell, or trade these permits. This means that companies have the flexibility to choose how they want to reduce their pollution levels or other external costs, as long as they stay within the limits established by the purchased permits.

Explain the Role of Marketable Permits in Environmental Policy

Marketable permits form a part of environmental policy known as "cap and trade" systems. Governments use these systems to regulate pollution or other negative externalities by allocating a fixed amount of permits (or "caps") to firms. This sets a limit on the total amount of pollution or other negative externalities that can be produced. Firms that can reduce their emissions or other externalities below their permit limits can then sell or trade their excess permits to other firms that need them. This creates an economic incentive for companies to reduce their pollution or other external costs and also helps governments achieve their environmental targets.

Discuss the Incentive for Firms

The incentive for a firm to account for external costs comes from the market created by the cap and trade system. If a firm can reduce its pollution or other external costs more efficiently than the market price of a permit, it may choose to do so and sell any excess permits at a profit. This provides an economic incentive for firms to innovate and invest in technologies and methods that reduce pollution or other negative externalities. On the other hand, if a firm is unable to reduce its pollution or other external costs below the level allowed by its permits, it can purchase or trade for additional permits from other firms that have reduced their emissions or externalities below their cap. This provides a financial incentive to account for external costs without significant disruption to the operations and allows the government to achieve their environmental targets by establishing the total allowable levels of pollution or external costs. In conclusion, marketable permits provide firms with incentives to take into account external costs by creating a competitive market for pollution reduction, encouraging innovation and investment in cleaner technologies, and offering flexibility to achieve government-regulated limits.