Suppose an industry emits a negative externality such as pollution and the possible methods to internalize the externality are command-and-control policies, Pigovian taxes, and tradable pollution permits. If economists were to rank these methods for internalizing a negative externality based on efficiency, ease of implementation, and the incentive for the industry to further reduce pollution in the future, they would probably rank them in the following order (from most favoured to least favoured):
A) Pigovian taxes, command-and-control policies, tradable pollution permits.
B) tradable pollution permits, Pigovian taxes, command-and-control policies.
C) tradable pollution permits, command-and-control policies, Pigovian taxes.
D) command-and-control policies, tradable pollution permits, Pigovian taxes.
E) They would all rank equally high because the same result can be obtained from any one of the policies.

Question

Quizplus · Accepted Answer

Economists generally consider tradable pollution permits to be the most efficient way to internalize the externality because they allow firms to trade permits and find the cheapest way of reducing pollution. Also, emissions are capped, so pollution reduction is guaranteed. However, implementation can be complicated because it requires setting up a market for the permits. 
Pigovian taxes are a close second because they provide a clear incentive for firms to reduce pollution, and the government can easily calculate the optimal tax to achieve the desired level of pollution reduction. However, they may be less effective at achieving a specific level of pollution reduction, and they may be more politically difficult to implement than tradable permits.
Finally, command-and-control policies are generally considered the least efficient because they specify exactly how firms must reduce pollution, which may not be the cheapest or most effective way to do so. However, they are easy to implement and enforce and provide clear guidelines for pollution reduction.

Suppose an Industry Emits a Negative Externality Such as Pollution