Pricing externalities

The efficiency of mechanisms to control activities with negative externalities is limited by uncertainty about the social costs of these activities. Existing regulatory mechanisms require negotiated compromise about either the prices of activities or the levels to be tolerated. We offer a mechanism in which today's price of an activity is a market-based estimate of future informed beliefs about the social cost of today's activity. This can be expected to increase the precision and accuracy of estimates of the right price and to make it likely that agents will base their decisions on better estimates of the harm they cause. Published by Elsevier B.V.