Spreading versus Concentrating Damages: Environmental Policy in the Presence of Nonconvexities

This paper examines the role of nonconvexities in externality control from a policy perspective. Nonconvexities can arise from a number of sources and can significantly alter the optimal solution to an externality problem; for instance, it may be socially desirable to concentrate externality damages in one area and prohibit them in another, rather than spread the effects of the externality across a number of sites. If this solution is optimal, a pollution tax will not achieve the social optimum, but a system of marketable permits will.