Suppose that the governmental authorities wished to decrease use of a pesticide that is leaching into groundwater supplies in a watershed by 60% from current use levels. Discuss the advantages and/or disadvantages of distributing marketable pesticide permits to each farm operating in the watershed equal to 40% of its current level of use of that pesticide, versus simply ordering each farm to reduce pesticide use to 40% of current levels under threat of heavy fines for non-compliance.
Take a shot, what do you think?
Hint: Assume the farmers place different values on the use of pesticides, especially at the margin. Which of the two scenarios is more likely to produce an internal market for pesticides. If there is a market, who will buy and who will sell, and how does that affect the efficient allocation of resources.
Hint 2: Think also about the ability to cheat under the two scenarios.