Pollution permits, property rights, state provision, regulation and information

Tradable pollution permits

The government sets a cap on total pollution and issues permits, each allowing one unit (for example one tonne of carbon dioxide). Firms must hold enough permits to cover their emissions. Firms that cut pollution cheaply can sell spare permits; firms for which cutting is expensive buy them. Example: the EU Emissions Trading System.

Advantages: total pollution is limited with certainty; pollution is cut by the firms that can do so most cheaply; firms have an incentive to invest in cleaner technology to sell permits; the cap can be tightened over time; if permits are auctioned, the government raises revenue.

Disadvantages: hard to set the right cap; if too many permits are issued, their price collapses and gives little incentive; monitoring emissions is costly; firms may relocate to countries without schemes ('carbon leakage'); pollution may be concentrated near firms that buy many permits.

Property rights

Many externalities happen because nobody owns the resource being damaged (air, rivers, seas). Extending property rights gives someone legal ownership, so they can charge for its use or take legal action against those who damage it. For example, giving fishing rights over a river to an owner who can sue a polluter. Problems: hard to assign rights over the atmosphere; legal action is slow and expensive; many small victims find it hard to act together.

State provision, regulation and information

• State provision: the government provides the good directly, financed by taxation and free (or cheap) at the point of use, for example defence, street lighting (public goods) and education and healthcare (goods with external benefits and information problems). Problems: opportunity cost, possible inefficiency without the profit motive, and difficulty knowing how much to provide.
• Regulation: rules backed by law, such as emission limits, bans (smoking in public places), minimum standards (food safety, building regulations), age limits, compulsory education or vaccination. Simple to understand and can act quickly, but needs enforcement and inspection, can be costly to firms, gives no incentive to go beyond the standard, and fines may be too small.
• Provision of information: campaigns, labelling and compulsory disclosure reduce information gaps, for example health warnings on cigarettes, nutritional labels, fuel-efficiency ratings, published school results. Relatively cheap, but people may ignore it and effects are slow.

Sectors where intervention occurs

The specification lists: health (state provision, vaccination programmes, tobacco taxes), housing (rent controls, social housing, planning rules), education (state schools, compulsory schooling), transport (fuel taxes, congestion charges, subsidised public transport), environment (pollution permits, regulation), energy (price caps, renewable subsidies), agriculture (minimum prices, subsidies, buffer stocks) and commodities (buffer stock schemes to stabilise prices). In essays, choose the method that matches the source of failure and the sector.

Worked example

A firm emits 100 tonnes of CO2 a year but is allocated 80 permits. Permits trade at $30 per tonne. The firm could instead cut emissions at a cost of $25 per tonne. What should it do and what does it cost?

1. It must cover 20 extra tonnes.
2. Buying permits: 20 x 30 = $600.
3. Cutting emissions: 20 x 25 = $500.
4. Abatement is cheaper, so the firm cuts its emissions.

Answer: Cut emissions by 20 tonnes at a cost of $500, saving $100 compared with buying permits.

Check yourself

1. A firm has 500 permits but emits 560 tonnes. Permits cost $18 each. How much must it spend on permits?
   Show answer

   $1080. It needs 60 more permits: 60 x 18 = $1,080.

2. A firm cuts its emissions from 300 to 240 tonnes but keeps its allocation of 300 permits. Permits sell for $22. How much can it earn by selling its spare permits?
   Show answer

   $1320. 60 spare permits x 22 = $1,320.

3. An advantage of tradable pollution permits over regulation is that
   • pollution is reduced by the firms that can do so at the lowest cost
   • they need no monitoring
   • the right cap is easy to set
   • they eliminate all pollution
   Show answer

   pollution is reduced by the firms that can do so at the lowest cost. Trading lets low-cost abaters cut more and sell permits.

4. Compulsory calorie labelling on restaurant menus is an example of
   • a maximum price
   • a tradable permit
   • state provision of a public good
   • provision of information to reduce an information gap
   Show answer

   provision of information to reduce an information gap. It helps consumers judge the costs of their choices.

5. A ban on smoking in enclosed public places is an example of
   • an indirect tax
   • regulation
   • a subsidy
   • a property right
   Show answer

   regulation. A rule backed by law and penalties.

6. Giving a fishing club legal ownership of a river so it can sue polluters is an example of
   • state provision
   • a minimum price
   • a subsidy
   • extending property rights
   Show answer

   extending property rights. Ownership gives a legal basis to charge or claim compensation.

7. Explain one disadvantage of a tradable pollution permit scheme.
   Show answer

   If the government issues too many permits, the cap is too generous and the permit price falls very low, so firms have little incentive to reduce pollution.. Over-allocation leads to a low price and weak incentive.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.