The fact that water flows to the lowest level uni-directionally is a very specific and useful property of water. By utilizing this property, we design a trading-ratio system (TRS) of tradable discharge permits for water pollution control. Such a trading-ratio system has three main characteristics: (1) the zonal effluent cap is set by taking into account the water pollutant loads transferred from the upstream zones; (2) the trading ratios are set equal to the exogenous transfer coefficients among zones; and (3) permits are freely tradable among dischargers according to the trading ratios. This paper shows that the TRS can take care of the location effect of a discharge and can achieve the predetermined standards of environmental quality at minimum aggregate abatement costs. Problems with hot spots and free riding can be avoided, and the burdens on both dischargers and the environmental authority should be relatively light.
Journal of Environmental Economics and Management 49(1), pp.83-102