Question:
Sometimes market activities (production, buying and selling) have unintended positive or negative effects outside the market's scope. This is called an externality. Suppose that you are a policy maker concerned with correcting the effects of gases and particulates emitted by and local power plant. What tools would you use? What would be the benefits of the action? What would be the costs? How would you decide what was the best level of emission reduction? Why do you think your approach would be better than others?
Cost and Benefit analysis can be used to justify eliminating pollution. There are two levels of analysis. The society must decide on the optimal level of pollution. For example, if a factory were creating $100,000 per year in damages due to pollution it would not make sense to pay $500,000 to eliminate it. It would be best to pay the damages of $100, 000 and continue to pollute. Second, if pollution should be eliminated, the society must decide how to eliminate the pollution: regulation (uniform abatement policy), tax on pollution, or selling permits to pollute. To understand the analysis, it is best to consider marginal benefit and the marginal cost of any new program or activity. See Chapter 31. Reminder: distinguish the analysis decision that determines how much pollution should be allowed from the analysis that determines "how" to eliminate the pollution. For external cost of production, see page 678. For additional sources, see Robert W. Crandall, "Pollution Controls", in Concise Encyclopedia of Economics, retrieved from https://www.econlib.org/library/Enc/PollutionControls.html