How do you convince your students of the ‘reciprocal nature of costs,’ when it is obvious (to Pigou and everyone else) that polluters are imposing costs on unwilling third parties? Or rather than convince, I mean how do you help your students to understand cost’s reciprocal nature and the implications of this point.

The “Paper River” exercise is one tool you’ve mentioned before. What else you got?

Good post. I’d add the observation that the economic problem with NSR is not simply that it fails to put a price on the externality of pollution, but that it fails to quantify the pricing unit. (e.g., it is not simply that we don’t pay per marginal lb of emissions, but also that we don’t measure the marginal lb of emissions). NSR is best understood as the output of an equation, the inputs to which are pass/fail emissions regulation and grandfathering of regulated sources. If you have a permit to release 15 ppm of NOx, you lose your operating permit if you emit 16 ppm and no one gives you any differential reward if you go to 13 ppm. It induces a nation of D-students, environmentally-speaking. Couple that with grandfathering – whereby your 15 ppm permit stays in effect even as standards tighten up over time and your competitors must now meet a 5 ppm standard – and NSR falls out of the equation. We need to be vigilant against new sources because the old sources have such a strong incentive to extract monopoly rents from their grandfathered facility.

This matters because a removal of NSR – or even a restructuring to put a price on pollution – puts the cart before the horse. Change to a system where pollution allowances are forecast into the future and emitters can buy/sell their over/under emission levels and NSR becomes irrelevant. But absent that change, there is no legitimate economic tool. As you say, markets don’t fail, they fail to exist.