The Evolution of Emissions Trading

Economists viewed the world through the eyes of Pigou (1920). Professor A. C. Pigou had argued that in the face of an externality, such as pollution, the appropriate remedy involved imposing a per-unit tax on the emissions from a polluting activity. The tax rate would be set equal to the marginal external social damage caused by the last unit of pollution at the efficient allocation. Faced with this tax rate on emissions, firms would internalize the externality. By minimizing their own costs firms would simultaneously minimize the costs to society as a whole. According to this view rational pollution control policy involved putting a price on pollution.