Pollution taxes and standards: A continuum of quasi-optimal solutions

A generalized second-best problem, involving a perfectly competitive industry which produces a pollution type of externality, is examined. The pollution tax is allowed to assume an arbitrary value (possibly zero), while a pollution standard, set as a ratio of pollution to output, is determined by a first-order optimizing condition. The general condition for a set of quasi-optimal solutions includes the Pareto-optimal solution as a special case. It is also found that when the pollution tax is below the optimal level, the usual implication is that the standard should be set so that the marginal cost of pollution reduction exceeds the marginal external damage.