Environmental economics tackles pollution using market-oriented tools. These approaches, like pollution charges and marketable permits, incentivize firms to reduce emissions. They're more flexible than traditional regulations, allowing companies to find cost-effective ways to cut pollution.

The choice of tool depends on the situation. Pollution charges work well when monitoring is easy, while marketable permits are great for controlling total emissions. Property rights assignments can be effective for localized issues. Each method has its strengths in different scenarios.

Market-Oriented Environmental Tools

Pollution Charges

• Pollution charges are fees imposed on firms for each unit of pollution they emit creates a direct financial incentive for firms to reduce their emissions as long as the marginal cost of reduction is less than the pollution charge
• Firms can choose the most cost-effective way to reduce emissions by investing in cleaner technology, changing production processes, or reducing output
• Pollution charges internalize the external costs of pollution forcing firms to consider the social cost of their emissions in their decision-making
• The higher the pollution charge, the greater the incentive for firms to reduce emissions and charges can be adjusted to achieve a desired level of emissions reduction

Marketable Permits and Property Rights

• Marketable pollution permits are a cap-and-trade system where the government sets a total limit (cap) on emissions and allocates permits to firms, each allowing a certain amount of emissions, which can be traded among firms
• Property rights assignments define who has the right to use a resource or emit pollution and according to the Coase theorem, if property rights are clearly defined and transaction costs are low, private negotiations can lead to efficient outcomes
• Marketable permits and property rights create a market for pollution where firms with low abatement costs will reduce emissions and sell excess permits, while firms with high abatement costs will buy permits instead of reducing emissions
• The market determines the price of permits, which reflects the marginal cost of abatement, and the total level of emissions is controlled by the government-set cap
• Marketable permits and property rights provide flexibility and cost-effectiveness in reducing emissions by allowing firms to choose the most efficient way to comply with the cap

Appropriate Policy Tools

• Pollution charges are suitable when monitoring emissions is relatively easy and inexpensive, pollution damage varies with the level of emissions, and firms have different abatement costs (carbon taxes)
• Marketable pollution permits are suitable when the total level of emissions needs to be controlled, firms have different abatement costs, and there are many polluters, allowing a market for permits to be established (sulfur dioxide trading)
• Property rights assignments are suitable when pollution affects a limited number of parties, transaction costs are low, and bargaining between parties is feasible (fishing quotas)
• Command-and-control regulations, such as emission standards, are suitable when pollution has severe and localized effects like toxic substances, monitoring emissions is difficult or costly, and there are few polluters with similar abatement costs (mercury emissions)
• The choice of policy tool depends on the nature and extent of the pollution problem, the characteristics of the polluting firms and affected parties, and the institutional and political context