Final answer:
Tradable pollution permits, or cap-and-trade systems, set the quantity of pollution allowed and are distributed among firms. This system ensures pollution reduction by allowing firms to trade permits, optimizing cost-effectiveness across the market.
Step-by-step explanation:
Tradable pollution permits, often referred to as a cap-and-trade system, are a mechanism for controlling pollution by providing economic incentives for achieving reductions in the emissions of pollutants. When a government sets up a marketable permit program, it begins by determining the overall quantity of pollution it will allow, which sets a cap on emissions to help meet national pollution standards. A set number of permits, which authorize the holder to emit a certain amount of pollution, are then distributed among firms.
Firms that find it cheaper to reduce emissions will do so and may end up with excess permits, which they can then sell to other firms. This market-based approach ensures that the total quantity of pollution will decline, while allowing the market to determine which firms reduce their emissions and by how much, generally favoring those for whom it is most cost-effective to implement reductions.