How does a marketable permit program encourage innovation in reducing externalities?

• A. Innovation is discouraged because permits are allocated based on historical emissions.
• B. Firms are required to use government-approved technologies, which leads to uniform innovation across the industry.
• C. Marketable permit programs eliminate the need for firms to invest in pollution control technologies.
• D. Firms can profit by developing new technologies that reduce emissions below their permit levels, allowing them to sell excess permits.

Answer: (D)

Verified step by step guidance

1. Understand that a marketable permit program sets a cap on total emissions and allocates permits to firms, each permit allowing a certain amount of pollution.
2. Recognize that firms can either use their permits to cover their emissions or reduce emissions below their permit level.
3. If a firm innovates and develops technology that reduces emissions more efficiently, it can emit less pollution than its permits allow.
4. The firm can then sell its excess permits to other firms that need to emit more, creating a financial incentive to innovate and reduce emissions.
5. This trading mechanism encourages firms to invest in new technologies because reducing emissions below permit levels becomes profitable.