The effects of marketable pollution permits on the firm's optimal investment policies

This paper considers a firm, which has to buy marketable pollution permits in order to be allowed to pollute the environment. Pollution is an inevitable byproduct of production and in our model two ways are offered to deal with it. The first is to buy marketable permits and the second is to clean up pollution which can be achieved through investing in abatement capital stock. The problem is formulated as a dynamic model of the firm and optimal control theory is used to form expressions for productive and abatement investments, and for equilibrium values of productive and abatement capital stock.