7. The control of an externality in a tradable permits system has three components. The first com

The control of an externality in a tradable permits system has three components. The first is providing incentives for abatement by internalizing the cost of the harm done by the pollution. The second is allowing parties to respond to those incentives by choosing the most efficient means of abatement. These means include reducing output, installing pollution-control equipment, redesigning products and production processes to reduce the pollution generated, and reducing the harm from emissions, as when oil refineries create safety zones around their facilities. The third component involves reflecting in the prices of goods and services, the costs of abatement and the social costs of the harm from the remaining pollution. This allows consumers to take into account the full social cost of the goods they consume. These three components operate simultaneously. An equilibrium results when (1) all advantageous trades have been made, (2) emitters have taken the abatement measures they prefer given the market price of permits, and (3) the quantities of products consumers purchase result in total emissions equal to the number of permits issued.