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- [Narrator] 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.
If we do this, 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."
[business man] 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.
If you want to test yourself, click "Practice Questions."
Or, if you're ready to move on, just click "Next Video."
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