The Optimal Number of Polluters and Victims and the Inadequacy of Pigouvian Taxes.

The paper analyzes in a general equilibrium model the local and global pollution externality problems in which one firm pollutes and another firm in another industry suffer from pollution. Assuming that polluters and victims are located near each other (otherwise there is no local pollution problem) in identical cities, it is shown that there is in the local case always a corner solution with respect to the number of polluters, victims or both in a city, whereas in the global case, an interior solution always exits. The optimal pollution control instrument is a two-part Pigouvian tax-emissions rights scheme in which the firm pays emission taxes only for those emissions which exceed its emission rights.