Tradeable permits

A market-based solution to correcting negative production externalities. The government issues or sells permits allowing firms to emit a pre-determined quantity of pollution (such as CO2) into the environment. If a producer wishes to exceed the amount they are permitted, they must purchase additional permits from other firms. Firms that reduce their emissions may sell permits they no longer require, adding to the firm’s revenues. Dirty firms end up paying more to produce, while greener firms earn greater revenues from selling permits they no longer require; thereby such a scheme creates a strong incentive to reduce pollution.

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