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Regulating a Polluting Firm Under Asymmetric Information
Authors:Lars Jebjerg  Henrik Lando
Institution:(1) Institute of Economics, University of Copenhagen, Denmark;(2) Institute of Finance, Copenhagen Business School, Rosenoerns Aue 31, 1970 Frederksberg, Denmark
Abstract:This paper reinterprets the Laffont-Tirole model of regulation under asymmetric information to cover the case of pollution control. The asymmetry of information concerns the firm's cost of lowering its pollution. The regulator has three objectives: Ensuring an efficient abatement level, generating 'green taxes' and securing the survival of the firm. We show that when optimal abatement is important relative to tax generation, the regulator cannot use the policy of offering the firm a set of linear tax schemes from which to choose. By contrast, this policy is optimal in the Laffont-Tirole model under certain not very restrictive assumptions. We proceed to establish a simple rule for when to shut-down inefficient types. In an example with specific functional forms, we derive the optimal tax function both analytically and graphically. We show the effect on the optimal tax system of a change in a technological parameter.
Keywords:Laffont-Tirole model  tax generation  tax schemes  pollution  regulator
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