Suppose the government knows the optimal quantity of pollution as well as how much it costs a particular polluting firm to reduce pollution at each quantity. If this is all the information the government has, which solution to reduce pollution is appropriate?

Government Solution : Pollution Emission Permits, 'Cap & Trade' pollution Economic Incentive, Pigovian Tax

Explanation:

Pollution is a negative externality, which has extra negative side effect (social cost), not accomodated in the market price.

The optimal pollution level is where : marginal cost of pollution abatement = marginal benefit from pollution abatement. Given, government knows the marginal cost of abatement (firm cost to reduce cost at each quantity)  & the determined optimal quantity of population.

Then, it should allocate the optimal pollution level as 'pollution emission permits' among all the pollutant firms. 'Cap & trade' system can also be used as economic incentive. It implies firms having less pollution emissions than the pollution emission permits, can sell their pollution permits to other firms, needing to emit pollution more than the permissible limit. Government can also apply pigovian tax = marginal social cost of the extra pollutant emission at the optimal level, to ensure pollution emission at optimal level.

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