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Efficient Pollution Control - Effluent Fees and Transferable Permits

Four firms located at different points on a river dump various quantities of effluent into it. The effluent adversely affects the quality of swimming for homeowners who live downstream. These people can build swimming pools to avoid swimming in the river, and firms can purchase filters that eliminate harmful chemicals in the material that is dumped into the river.

As a policy advisor for a regional planning organization, how would you compare and contrast the following options for dealing with the harmful effect of the effluent:

a.) An equal rate effluent fee on firms located on the river.
b.) An equal standard per firm on the level of effluent each firm can dump.
c.) A transferable effluent permit system in which the aggregate level of effluent is fixed and all firms receive identical permits.

Solution Preview

a. An equal rate fee will cause firms to raise their prices, effectively passing the cost on to consumers. This has the advantage of directly internalizing the negative externality by pricing the use of the environment into the cost of the product. People will buy less at the higher price, and less pollution will be produced.

b. An equal standard will prevent firms from continuously increasing the amount they dump. ...