=+12.9* Business and Policy Application: Investing in Smokestack Filters under Cap-and-Trade: On their own, firms have little incentive to invest in pollution-abating technologies such as smokestack filters.

As a result, governments have increasingly turned to “cap-and-trade” programs. Under these programs, discussed in more detail in Chapter 21, the government puts an overall “cap” on the amount of permissible pollution and firms are permitted to pollute only to the extent to which they own sufficient numbers of pollution permits or “vouchers.” If a firm does not need all of its vouchers, it can sell them at a market price pv to firms that require more.

A. Suppose a firm produces x using a technology that emits pollution through smokestacks. The firm must ensure that it has sufficient pollution vouchers v to emit the level of pollution that escapes the smokestacks, but it can reduce the pollution by installing increasingly sophisticated smokestack filters s.