Violation-minimizing fine schedules

An analysis is conducted of the issues of optimal monitoring behavior and the optimal fine structure for a regulatory authority trying to control the firm's choice of pollution in the presence of an upper bound on the financial penalty per period that can be imposed upon a firm. It is assumed that the regulator knows the cost function and the maximum fine applicable to each firm. It is found that the fine structure that produces the lowest level of excess pollution for a given level of monitoring expenditure is one that offers a zero fine up to a critical pollution level and then makes the fine equal to the maximum possible. Given the regulatory goal of minimizing damage plus pollution control plus monitoring, it is shown that marginal damage pollution should be equal to the sum of the marginal cost of pollution reduction and the marginal cost of required pollution monitoring. It is the sum of these last 2 marginal costs that should be equated across firms to arrive at a given total amount of pollution reduction at a minimum cost.