Environmental & Resource Economics

Consider the case of a regulator and a single polluter. Suppose the regulator knows the marginal damage from pollution but is unsure about the firm's marginal savings from emitting. The regulator asks the firm to reveal its marginal savings from emitting schedule. Regulators know that if they use an emission fee or a permit system, the firm has an incentive to lie about it marginal savings. Explain why this is the case. As a result, the regulator announces that after being told the firm's marginal savings, the regulator will flip a coin to determine whether an emission fee or an emission permit will be used to control pollution. In this case, will the firm have an incentive to truthfully reveal its marginal savings from emissions? Why or why no? [Hint: Assume a firm is low cost; look at the possible costs or cost savings from telling the regulator it is high cost].