marginal benefit of abatement. As the price of the permit increases, each
firm says to itself: “At a higher price for permits, polluting becomes more
expensive, so we will abate more and purchase fewer pollution permits.”
Thus, the demand curve for pollution permits is downward sloping, as
shown in Figure 17-6. At the equilibrium price for pollution permits,
the number of permits demanded by firms will exactly equal the number
of permits issued by the government.
In the market for pollution permits, the quantity is set by government policy. Given that
quantity, the equilibrium price is determined by firms’ demand for pollution permits.Technological Improvement
One problem with direct regulatory controls is that they tend, like much
government regulation, to respond only slowly to changes in technology
or market conditions. In contrast, cap-and-trade systems, because they
are a market-based method of pollution control, maintain their efficiency
even in the midst of frequent and substantial changes in technology. As
technological advances occur that reduce the marginal costs of pollution
abatement, profit-maximizing firms will choose to abate more pollution at
any given price for the pollution permits (see Figure 17-5 ). But this
decision will imply a reduced overall demand for pollution permits and
thus the equilibrium price for the permits will fall (see Figure 17-6 ).
Whatever the market price for permits, however, profit-maximizing firms
will equate the price to their marginal abatement costs, thus minimizing
the total cost of a given amount of pollution abatement.