Regulating Pollution with Endogenous Monitoring

The paper offers a new perspective on nonpoint source pollution by explicitly considering the cost of monitoring individual emissions. The distinction between point and nonpoint source pollution is shown to depend on the cost of monit oring, the environmental cost of pollution, and the impact of monitoring on profits. A regulatory scheme of differential taxation is proposed, wherein taxes a re predicated on whether the agent has installed an emissions monitoring device. The optimal degree of monitoring as well as conditions for optimal regulation in the extreme cases of no monitoring and full monitoring, is identified.