Measurement error and state-dependent pollution control enforcement

A two-group model of state-dependent enforcement is applied to identical firms which minimize the expected present value of costs and fines. Measurement error affects the probabilities of transitions between groups and the receipt of fines. It is shown that state-dependent enforcement can reduce social cost below the level attainable with static enforcement and that differentiation in both monitoring probabilities and standards may be optimal. However, setting fines for both groups at the maximum is likely to be optimal. Comparisons between models and alternative model interpretations are offered.