Suppose an industry emits a negative externality such as pollution and the possible methods to internalise the externality are command-and-control policies, Pigovian taxes, and tradable pollution permits. If economists were to rank these methods for internalising a negative externality based on efficiency, ease of implementation, and the incentive for the industry to further reduce pollution in the future, they would probably rank them in the following order (from most favoured to least favoured):

Question

Quizplus · Accepted Answer

Tradable pollution permits are the most efficient method of internalising the externality because it allows the industry to find the most cost-effective way to reduce pollution. Pigovian taxes come in second because it provides a financial incentive for the industry to reduce pollution while also generating revenue for the government. Command-and-control policies are the least efficient because they do not provide any flexibility for the industry to find the most cost-effective way to reduce pollution.

Suppose an Industry Emits a Negative Externality Such as Pollution