Do We Need the Entry-Exit Condition on Polluting Firms?

Given that marginal pollution damage increases with emissions, a polluting firm′s total Pigouvian tax payments will exceed the total damage that it causes. There is a long-standing concern in the environmental economics literature that this disparity could force a polluting firm to shut down even though its net social product is positive. However, such a problem exists only in a partial equilibrium analysis. In a conventional general equilibrium model with standard neoclassical, price-coordinated firms, the fact that Pigouvian taxes exceed total damages is as normal a phenomenon as producer or consumer surplus.