Consider the case of a single polluter and regulator. The regulator knows the marginal benefit of pollution abatement (equivalent to saying the regulator knows the marginal damage from pollution) but he does not know the marginal cost of pollution abatement for the firm. If the regulator proposes to implement a fee on pollution and asks the polluter to reveal the marginal cost of abatement, discuss how the polluter will respond and type of outcome that would result.
Alternatively, if the regulator proposes to give away free permits what would happen?
What if the regulator announces a coin flip will decide whether the policy will be fees or free permits.