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 permit allowing its holder to discharge a specific amount of pollution or use a certain amount of resources, which can be traded among firms. It helps solve externalities by setting a cap on pollution or resource usage, creating a market for allowances, and promoting efficient resource use. Marketable permits incentivize firms to account for external costs through cost savings from selling excess permits, compliance with regulations, and gaining a positive reputation and competitive advantage.

Step-by-step solution

Define Marketable Permit

A marketable permit, also known as a tradable permit or emissions trading, is a permit that allows its holder to discharge a specific amount of pollution or use a certain amount of natural resources. These permits can be bought, sold, or traded among firms, allowing them to adjust their level of emissions or resource usage based on their needs and costs.

Role of Marketable Permit in Solving Externalities

Externalities are the costs or benefits that affect a party who did not choose to incur those costs or benefits, such as pollution produced by a factory that negatively impacts nearby residents. Marketable permits can help solve the problem of externalities by setting a cap on the total amount of pollution or resource usage allowed, and then distributing permits to firms. As firms find ways to reduce their pollution or resource usage, they can sell their excess permits to other firms. This creates a market for pollution allowances and promotes efficient use of resources, ultimately leading to a decrease in the overall level of pollution or resource consumption.

Incentives for Firms to Account for External Costs

Marketable permits provide several incentives for firms to account for external costs. These include: 1. Cost Savings: By reducing their emissions or resource usage below the level allowed by their initial permit allocation, firms can sell their excess permits to other firms. This provides a financial incentive for firms to invest in cleaner technologies or more efficient production methods. 2. Compliance with Regulations: Tradable permits enable firms to meet their regulatory obligations while maintaining flexibility in their production choices. If a firm cannot reduce its emissions or resource usage enough to comply with its permit allocation, it can purchase additional permits from other firms. This is often more cost-effective than investing in new equipment or overhauling production processes. 3. Reputation and Competitive Advantage: Firms that are proactive in reducing their environmental impact may gain a positive reputation in the eyes of consumers, investors, and regulators. This can lead to increased market share, access to capital, and the ability to attract and retain top talent. In conclusion, marketable permits provide an economic incentive for firms to account for external costs, as they promote efficiency in resource use and enable firms to monetize their efforts to reduce pollution and resource consumption.