Tradable pollution permits are another option the government has to correct certain types of market failure. A pollution permit allows the owner to pollute up to a specific amount of pollution. These permits can also be traded, as the name gives away. The total number of permits available is strictly controlled by the government, so that they can limit the maximum pollution level to whatever they want it to be. Companies have to buy they permits in order to pollute, therefore the incentive is for companies to invest in greener technology to reduce pollution and overall reduce their costs by cutting out the need to buy permits. Any permits that are unused by companies can be sold on to other companies to generate some money. Companies exceeding their limit of pollution will face legal action and prosecution.
The theory is that a fixed supply of pollution permits will be allocated. Then, if demand for these permits rise because companies need to pollute more then the price will rise. This price rise will increase the incentive for companies to invest in green technology so their costs are lower.
Tradable pollution permits do come with their drawbacks, as with all methods of government intervention. The first problem is calculation what price to put the permits at initially. If the price is too high then companies won't be able to afford them and production will fall. If the price is too low then it will have no effect on the market failure of too much pollution. Another problem will be the additional cost to the government of policing and enforcing the scheme, it will be a costly affair and thus may not be the most effective method of fixing market failure.
That's the lot, next post may be delayed as i'm busy with exams. Thanks.
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