Question

Suppose that a government imposes an emmision standard, and per-unit fines for exceeding that standard, at the socially efficient pollution level. if polluters believe that the probability of detecting standard breaches is not certain, illustrate the privately efficient outcome and any associated welfare loss. What per unit fine would induce a socially efficient outcome?

Answer 1

Compliance benefits tend to be high at early rate of compliance because the fear of being caught or magnitude of the punishments for a firm is higher when it does not comply at all or comply a little bit than another firm which complies at higher rate than the earlier firm.

Similarly, when firms comply more and more then the fear or magnitude of punishment lessens as the likelihood of being caught reduces. To which, the benefits seem lesser at higher rate of compliance.

If polluters have some probability assurance that detecting standard breaches is not certain then each pollter will abate or reach a level of pollution reduction below from which the fine would cost him more than the incentive to pollute less.

in other owrds lets say there is 50% chance of failure of detection. Because of this 50% chance polluters have 50% chance of saving from not abating till the imposed standard. The polluetrs will not abate above the level where the saving from 50% chance of not being caught would be more than the fine that they would have to pay if they get caught.

In order to make the solution socially efficient the tax should be equal to the saving that they would save from not abatiing till the standard level.