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-issued permit allowing firms to emit a certain amount of a specific pollutant. These permits can be traded among firms, creating a market for pollution rights. This system provides incentives for firms to account for external costs and reduce pollution emissions by promoting cost efficiency, profit opportunities, and regulatory compliance.

Step-by-step solution

Defining a Marketable Permit

Marketable permits are government-issued permits that give firms the legal right to emit a certain amount of a specific pollutant over a given period of time. These permits can be bought, sold, and traded among firms in a marketplace, allowing for flexibility and the efficient allocation of pollution rights.

Explaining How a Marketable Permit System Works

In a marketable permit system, the government sets a cap on the total amount of emissions allowed for a specific pollutant, and then issues permits accordingly to firms in the market. Each permit grants the holder the right to emit a certain amount of the pollutant. Firms that need to emit more than their allotted permits must purchase additional permits from other firms who have surplus permits. Similarly, firms that can reduce their emissions below their allotted permits can sell their excess permits to other firms for a profit. This system creates a market where the price of a permit is determined by the supply and demand for pollution rights.

Understanding the Incentives Provided by Marketable Permits

The marketable permit system provides several incentives for firms to account for external costs and reduce their pollution emissions: 1. Cost Efficiency: By allowing firms to trade permits, the system ensures that emission reductions are achieved at the lowest possible cost. Firms with lower costs for reducing emissions can sell their excess permits to firms with higher costs, resulting in an overall cost-efficient distribution of pollution reductions across the market. 2. Profit Motive: Since permits can be sold for a profit, firms have an incentive to reduce their emissions below their allotted permits. This encourages firms to invest in cleaner technologies and more efficient production processes in order to cut their emissions and secure a profit from selling surplus permits. 3. Regulatory Compliance: Firms are compelled to either reduce their emissions to stay within the limits set by their permits or purchase additional permits to cover their excess emissions. This ensures that the overall cap on emissions is maintained and firms are held accountable for the external costs of their pollution.

Concluding Remark

In conclusion, marketable permits are a policy tool used to regulate pollution emissions by creating a market for pollution rights. This system provides incentives for firms to account for external costs and to comply with the established emissions cap by encouraging cost efficiency, profit-making opportunities, and regulatory compliance.