Economics incentives are increasingly being used to achieve environmental policy goals. Economists have demonstrated that these approaches can potentially achieve more, at a lower cost, than inflexible regulatory approaches. The key reason for this is that they allow a decentralized response by individuals who face individual choices where polluting involves higher costs. If well designed and implemented, these policies "harness market forces" by encouraging firms to undertake pollution control efforts that simultaneously achieve their own interest and meet policy goals (Stavins 2001). According to the National Center for Environmental Economics (NCEE), a division of the U.S. Environmental Protection Agency (U.S. EPA), "once considered an academic abstraction or a revenue-raising adjunct to traditional regulatory mechanisms, market-based economic incentives are being used now as the principal instrument for controlling a growing number of environmental problems" (NCEE 2001).

Examples of these market-based instruments include tradable SO2, CO2 and water pollution permits, water supply markets, and wetland mitigation banking (see http://www.co2e.com for an example of an online CO2 permit market). A catalog of the kinds of incentive policies relating to environmental policies has been compiled by Robert Stavins (2001). See the linked tables for a summary of these programs. His detailed analysis can be found here. Descriptions and assessments of four of these market-based solutions are linked here for western water markets, wetlands mitigation banking, and water quality trading. Additionally, an NCEE table of the various uses of economic incentives in environmental policy and examples of corresponding instruments is provided here.

Market-based instruments have the potential to provide the lowest cost solution to an environmental problem. In the case of tradable permits, some firms with low-cost pollution abatement can sell pollution credits to firms with higher abatement costs, and farmers irrigating low value crops can trade water rights to higher-value urban uses. Although these market-based instruments have been proposed as methods to address a broad range of environmental issues, their prevalence has been somewhat limited in part due to some both real and perceived concerns. First, all transferable rights require an institution (such as the government) to certify that the right can be transferred and to regulate that individuals and firms are complying with market regulations. Second, market instruments may not result in desirable distributional outcomes. There is often concern that ownership will become concentrated and lead to market manipulation.