A subsidy works as a negative tax and can be used to increase pollution abatement. Firms would receive a subsidy per unit of pollution abatement or as a lump sum in the form of a grant, loan or tax allowance which they would then spend of pollution abatement. If it is per unit of pollution reduction subsidy and is set at the same rate as a tax (MAC=MD) then the effects are symmetric and the graph would be the same as a tax (see Figure 1). The firm would reduce their level of pollution until the subsidy equalled their MAC and then would not reduce their pollution any further as they would have to lose money to do …show more content…
Under tradable permits, the government sets the level of pollution allowed per firm, and supplies the corresponding fixed level of permits available in the economy (S1). By introducing permits, the government has created an incentive for firms to reduce pollution, and if they are successful in reducing their pollution, firms can sell their extra permits to make a profit. Figure 3 shows the Market for Pollution Permits, when the government first introduces tradable permits (S1) the market demand is Q1 at a price of P1. Firms can decide to; (1) take the cost of reducing pollution, investing in green technology or increasing the efficiency of their factors of production, or (2) continue to pollute at the same level and buy permits at the market price. The firm will choose the option that will cost the least amount of