Review these two excerpts that explain two very different approaches for dealing with negative externalities. : Excerpt 1:

Command and control is pretty much what it sounds like. The government says, "You cannot do some things or you must do some things." For example, the Department of Energy in an effort to reduce the consumption of electricity, recently said that it is illegal to sell washing machines in the United States if they consume more than a certain amount of electricity. The only washing machines that it was legal to sell had to consume less than this amount of electricity. So, what were the results of this command and control program? Well, here's Consumer Reports: "Not so long ago you could count on most washers to get your clothes very clean. Not anymore. What happened?

As of January 2007, the US Department of Energy has required washers to use 21% less energy... but our tests have found that traditional top-loaders-- those with the familiar center-post agitators-- are having a tough time wringing out those savings without sacrificing cleaning ability..."

So the government said you have to use 21% less energy, but if things were that easy everyone would do them. There are trade-offs everywhere, and by requiring the washing machines to use less energy, the trade-off is they didn't clean so well. Eventually, the technology has gotten better and will get better, and perhaps, this will be possible. But one of the problems with a command and control approach, is that the government is not always aware of the trade-offs. They're not always able to choose the least cost way of achieving a goal. Let's take a closer look at this problem.

Command and control is rarely an efficient way of achieving a goal. Why not? Well, there many ways to achieve most goals. For example, let's look at some of the ways in which we could use less electricity. We could turn down our thermostat a little bit. We could shut the lights off when we leave a room. We could turn off our computers at night when we're not using them. We could use more solar power. Firms which use a lot of electricity have many, many different ways to use less by adjusting their production processes.

Now if we want to cut back electricity consumption by, say, 10%, we want to cut back on the 10% of electricity uses which are least valuable. We want to reduce electricity use in the way which is least costly. The problem is, out of all of the millions, and perhaps, billions of ways of reducing electricity, is government going to choose to command and control us to reduce electricity in the least cost way? Probably not. Government simply does not have enough information to order the least costly method of reducing electricity consumption.

Now, let's compare our command and control with an alternative method, a tax on electricity. A tax on electricity would allow the users-- would give them flexibility-- to find the lowest cost ways to reduce their use of electricity. If a tax of, let's say, a few percentage points would reduce electricity consumption by exactly the same amount as the command and control approach. The difference is, is that each one of us would look at the higher price of electricity and would choose, based upon our different circumstances and knowledge and flexibility, which ways we could reduce electricity in the least cost.

Some of us would turn down lights, some of us would turn down thermostats, some firms would change the production processes a lot, others would change their production processes just a little bit. Each one of us would access our own information, and in this way with much, much, much greater flexibility, we could reduce electricity consumption by exactly the same amount as the command and control approach. But we would do so at much lower cost because each user of electricity would have the flexibility to choose the least cost ways of doing it.

Think about it-- how many people would choose to reduce electricity by paying a lot more for a washing machine that doesn't clean very well? Probably not too many. That illustrates that when government chose to reduce electricity consumption by requiring washers to be "more efficient" that actually wasn't the least-cost way of reducing electricity. That was actually a very high-cost way of reducing electricity, because it meant that we had dirty clothes and we really didn't want that.

Finally, let's remember that the goal is not actually to use less electricity. The goal is to reduce pollution. That's why a Pigouvian tax is really one of the most efficient ways of reducing or controlling an externality, because a Pigouvian tax is targeted on the problem-- the pollution. So, the closer we can get the tax to the good which is actually causing the problem-- which is not electricity but instead which is pollution-- the more efficient, the lower cost way we will have of solving the externality problem, of reducing pollution at least cost.

Is command and control ever a good solution? Yes, it can be precisely when flexibility is not a virtue. So, if the best approach to the problem is well known-- we don't need experimentation and innovation and new ideas-- we know the best approach, and if success requires very strong compliance-- that is when flexibility is not a good thing-- then command and control may be the best approach.

So for example, let's consider the eradication of smallpox. Now, smallpox is a terrible disease. It has killed more people in the history of the world, billions of people, than, perhaps, anything else, except, perhaps, old age. To get rid of smallpox we had to isolate-- every single time there was a new case of smallpox-- we had to isolate the people with the smallpox and vaccinate everyone in the surrounding community. And the World Health Organization and other organizations did this time and time again.

Wherever a case, anywhere in the world, of smallpox appeared, we isolated and vaccinated. And over time smallpox had fewer and fewer places to hide, until by 1979, there were no places to hide left. Smallpox had been eradicated from the face of the planet. That was a tremendous boon to humanity, but really the only way it could have been done was command and control. If we'd subsidized vaccinations, that would not have been enough, because that inevitably would have led to small pockets of people who were not immunized and they would've continued to be carriers to spread it to other people in the world. So, command and control got us very strong compliance and it eradicated smallpox from the world-- and that was a tremendous thing.

Very briefly, let's just say where we've been and where we're going. We've been looking at solutions to externality problems. So far we've looked at two: Pigouvian taxes and Pigouvian subsidies-- Pigouvian taxes for external cost and Pigouvian subsidies when there are external benefits-- and command and control. The next thing we want to do is to look at the Coase theorem and private solutions to externality problems. It turns out that we've been a little bit too pessimistic. There can be some market or private solutions to externality problems in certain circumstances, and that's covered by the Coase theorem.

The last thing we're going to do is look at tradable allowances. These have been extremely important in practice in reducing acid rain, and may become more important in the future in dealing with global climate change. Tradable allowances, as we'll see, are a sort of combination of command and control, and ideas from Ronald Coase-- and it actually turns out to be quite similar to Pigouvian taxes and subsidies in the end as well. So, that's where we're going-- Coase theorem and private solutions and then tradable allowances. Excerpt 2 When gasses like sulfur dioxide and nitrogen oxide are emitted into the atmosphere, they react with water, oxygen, and other chemicals to form sulfuric and nitric acid, and when these acids precipitate, we get acid rain. Acid rain can kill trees, plants, and fish, as well as erode automobile paint, buildings, and stone. The Clean Air Act Amendments of 1990 introduced a novel way to combat acid rain -- tradable permits.

Here's how they work. Let's consider two power plants or factories that are polluters. They emit this much polluting gas. The government could control pollution by just commanding that all factories install certain technologies, like scrubbers. Using this command and control method, suppose that pollution would be reduced to this. Okay, but now imagine that one of the plants can reduce pollution at a lower cost than the other. Perhaps it's newer or it uses a different type of coal or maybe there is some other technology for reducing pollution that the government didn't consider. Or perhaps the product produced in one of these factories has a less polluting substitute that we can easily switch to.

Ideally, we want to reduce pollution here where reducing pollution has a low cost, and less here, where reducing pollution has a high cost. We can reduce pollution by exactly the same amount as before but we can do it while wasting fewer other resources. Great, but wait. Unfortunately, the government doesn't know which plant is the low cost plant. Remember there are lots of ways of reducing pollution, lots of substitutes, and lots of substitutes for substitutes. No one person knows all the trade-offs. Information is dispersed.

So how can we draw on this dispersed information and harness the energy of entrepreneurs to discover the best ways to reduce pollution? Instead of commanding how to reduce pollution, suppose the government issues pollution permits -- rights to emit pollution. One permit gives you the right to emit say one ton of polluting gases. Pollution permits don't sound very environmentally friendly, but the government only issues a limited number of permits, and that equals the same total reduced pollution as under command and control.

So in the end, pollution reduction is the same. By allowing the permits to be bought and sold, the profit seeking self-interest of power plant owners is harnessed for the social good. The owner of the power plant with the low cost for reducing pollution thinks, "I don't have to use my permits. I can reduce pollution at my plant for less money than I can get by selling my unused permits and make a tidy profit." Oh yeah. - Meanwhile, the power plant owner with the high cost wants to buy permits, and is willing to pay a lot, because it's cheaper to buy permits than reduce pollution at high cost. So the power plant that can cheaply reduce pollution sells permits, and the power plant where it's expensive to reduce pollution buys permits. Both firms increase their profit.

In this way, the invisible hand of the market gets us to the ideal solution. We reduce pollution more here, where reducing pollution is cheap, and less here, where reducing pollution is expensive. The total amount of pollution, however, is reduced just as much as with command and control, but at a lower cost. In fact, the tradable permit approach worked so well, it reduced air pollution at a much lower cost than any expert had anticipated.

Why should we care about the cost of reducing pollution? Spending less on reducing pollution means that we have more to spend on other goods. But also, don't forget the law of demand. The lower the price of pollution reduction, the more pollution we want to reduce. Tradable permits uses the invisible hand of the market to discover the lowest cost way of reducing pollution and that's good for everyone. Question: What are the costs and benefits of each approach? If you were the director of the Environmental Protection Agency, which method would you use to deal with reducing pollution?