But while the direct regulation of activities that cause pollution makes sense in some cases, it is seriously defective in others, because it does not offer any scope for flexibility and creativity. Consider the biggest environmental issue of the 1980s — acid rain. Emissions of sulfur dioxide from power plants, it turned out, tend to combine with water downwind and produce flora- and wildlife-destroying sulfuric acid. In 1977, the government made its first stab at confronting the issue, recommending that all new coal-fired plants have scrubbers to remove sulfur dioxide from their emissions. Imposing a tough standard on all plants was problematic, because retrofitting some older plants would have been extremely expensive. By regulating only new plants, however, the government passed up the opportunity to achieve fairly cheap pollution control at plants that were, in fact, easy to retrofit. Short of a de facto federal takeover of the power industry, with federal officials issuing specific instructions to each plant, how was this conundrum to be resolved?

Enter Arthur Cecil Pigou, an early-20th-century British don, whose 1920 book, “The Economics of Welfare,” is generally regarded as the ur-text of environmental economics.

Somewhat surprisingly, given his current status as a godfather of economically sophisticated environmentalism, Pigou didn’t actually stress the problem of pollution. Rather than focusing on, say, London’s famous fog (actually acrid smog, caused by millions of coal fires), he opened his discussion with an example that must have seemed twee even in 1920, a hypothetical case in which “the game-preserving activities of one occupier involve the overrunning of a neighboring occupier’s land by rabbits.” But never mind. What Pigou enunciated was a principle: economic activities that impose unrequited costs on other people should not always be banned, but they should be discouraged. And the right way to curb an activity, in most cases, is to put a price on it. So Pigou proposed that people who generate negative externalities should have to pay a fee reflecting the costs they impose on others — what has come to be known as a Pigovian tax. The simplest version of a Pigovian tax is an effluent fee: anyone who dumps pollutants into a river, or emits them into the air, must pay a sum proportional to the amount dumped.

Pigou’s analysis lay mostly fallow for almost half a century, as economists spent their time grappling with issues that seemed more pressing, like the Great Depression. But with the rise of environmental regulation, economists dusted off Pigou and began pressing for a “market-based” approach that gives the private sector an incentive, via prices, to limit pollution, as opposed to a “command and control” fix that issues specific instructions in the form of regulations.

The initial reaction by many environmental activists to this idea was hostile, largely on moral grounds. Pollution, they felt, should be treated like a crime rather than something you have the right to do as long as you pay enough money. Moral concerns aside, there was also considerable skepticism about whether market incentives would actually be successful in reducing pollution. Even today, Pigovian taxes as originally envisaged are relatively rare. The most successful example I’ve been able to find is a Dutch tax on discharges of water containing organic materials.

What has caught on instead is a variant that most economists consider more or less equivalent: a system of tradable emissions permits, a k a cap and trade. In this model, a limited number of licenses to emit a specified pollutant, like sulfur dioxide, are issued. A business that wants to create more pollution than it is licensed for can go out and buy additional licenses from other parties; a firm that has more licenses than it intends to use can sell its surplus. This gives everyone an incentive to reduce pollution, because buyers would not have to acquire as many licenses if they can cut back on their emissions, and sellers can unload more licenses if they do the same. In fact, economically, a cap-and-trade system produces the same incentives to reduce pollution as a Pigovian tax, with the price of licenses effectively serving as a tax on pollution.

Paul Krugman is a Times columnist and winner of the 2008 Nobel Memorial Prize in Economic Science. His latest book is “The Return of Depression Economics and the Crisis of 2008.”