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Optimal Pollution Regulation in a Dynamic Stochastic Model


  • Sudhir A. Shah

    (Delhi School of Economics)


We model the interaction between a regulator and a polluting firm in the optimal mechanism design setting. The particular aspect of the interaction that we model is the regulator's problem of providing incentives to induce optimal adoption of pollution processing technology by the firm, subject to implementability constraints created by informational and incentive considerations. The regulator's welfare function is a formalization of the various conflicts and trade-offs that arise from the phenomenon of pollution. Our model offers a general, yet tractable, dynamic stochastic description of the pollution-creating technology used by the firm and characterizes the optimal contract in terms of a limited number of parameters that can be estimated directly from statistical data for the purpose of simulation and econometric testing.

Suggested Citation

  • Sudhir A. Shah, 2000. "Optimal Pollution Regulation in a Dynamic Stochastic Model," Working papers 84, Centre for Development Economics, Delhi School of Economics.
  • Handle: RePEc:cde:cdewps:84

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    References listed on IDEAS

    1. Xepapadeas, A. P., 1992. "Environmental policy, adjustment costs, and behavior of the firm," Journal of Environmental Economics and Management, Elsevier, vol. 23(3), pages 258-275, November.
    2. Mark Bagnoli & Ted Bergstrom, 2005. "Log-concave probability and its applications," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 26(2), pages 445-469, August.
    3. Keeler, Emmett & Spence, Michael & Zeckhauser, Richard, 1972. "The optimal control of pollution," Journal of Economic Theory, Elsevier, vol. 4(1), pages 19-34, February.
    4. R. C. D'Arge & K. C. Kogiku, 1973. "Economic Growth and the Environment," Review of Economic Studies, Oxford University Press, vol. 40(1), pages 61-77.
    5. Harrison, J. Michael & Taylor, Allison J., 1978. "Optimal control of a Brownian storage system," Stochastic Processes and their Applications, Elsevier, vol. 6(2), pages 179-194, January.
    6. C. G. Plourde, 1972. "A Model of Waste Accumulation and Disposal," Canadian Journal of Economics, Canadian Economics Association, vol. 5(1), pages 119-125, February.
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    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation


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