Citizen's Demand for Permits and Incentive Compatible Mechanisms for Pollution Control

An interesting feature of pollution permit markets is that citizens may purchase permits to directly lower the levels of pollution. We analyze the effects of citizens' demand for permits on incentive compatible mechanisms for pollution control that are based on permit markets. We show that Kwerel's mechanism (Review of Economic Studies - 1977) is not incentive compatible. We show that two other mechanisms - the simple mechanism and the minimum-price mechanism - are at least weakly incentive compatible. Furthermore, the minimum-price mechanism is robust to free-riding among citizens and uncertainty about damages from pollution