ON THE DYNAMICS OF THE REGULATION OF POLLUTION - INCENTIVE COMPATIBLEREGULATION OF A PERSISTENT POLLUTANT

Consider the optimal regulation of a persistent pollutant. Because the pollutant is persistent, the levels of pollution in neighboring perio ds are causally related, and it is necessary to determine an optimal t rajectory of emissions. The optimal level of emissions in any period d epends on the costs to reduce emissions, but these costs are generally private information to the polluting firms. A regulatory agency may s olicit firms' cost functions, but if the firms know how the agency wil l use the information they provide, they may have an incentive to lie. Hence the agency's problem is to design a regulatory scheme that elic its truthful responses from firms and achieves the optimal trajectory of emissions. This paper describes such a scheme, the extension to a d ynamic setting of a scheme found by Evan Kwerel. The purpose of this p aper is to describe: this ''dynamic Kwerel scheme,'' derive its proper ties, and describe the associated trajectory of emissions. (C) 1998 Ac ademic Press.