Avoidance Costs and the Entry‐exit Condition on Polluting Firms

When marginal environmental damages increase with emissions, it is said to be a problem for entry and exit that the marginal firm pays more in Pigouvian taxes than the actual damages it causes. Accordingly it is sometimes assumed that over the range of an individual firm's emissions, marginal environmental damages are approximately constant. When avoidance costs are added to environmental damages, however, the inequality may be reversed so that the assumption of constant marginal damages may aggravate rather than eliminate the alleged problem.