Question 3 : The Clean Air Act of 1990 established control of sulfur dioxide emi

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Question 3 : The Clean Air Act of 1990 established control of sulfur dioxide emissions through the use of tradable permits . Tradable permits work because polluters and victims can trade the rights to pollute in a "market" where transaction costs are low. The program quite effective in reducing emissions over traditional me thods for controlling pollution such as fines and requi ring scrubbers on plants. Let's assume that each permit controls 1 unit of pollution. Only consider 1 unit increments of pollution (i.e. you cannot have one - half, one - third, one - fourth , etc . permits). Using the information in the table below, answer the following questions (15 points).

# of Permits                           Total benefit to Polluting Farmers                   Total Cost to Pollution Victims

0                                            0                                                                        0

1                                           30                                                                      10

2                                           55                                                                      30

3                                           75                                                                      60

4                                           90                                                                      100

5                                           100                                                                    150

6                                           105                                                                    210

A. Assume the government begins by giving all the permits to the pollution firms. What will be the efficient number of permits? Explain how the market arrives at this point. Use a diagram to illustrate your argument.

B. Assume the government begins by giving all the permits to pollution victims. What will the efficient number of permits? Explain how the market arrives at this point. Use a diagram to illustrate your argument.

C. Aside from restricting the number of permits, how else can the government influence the level of air pollution?

Explanation / Answer

A.) The number of permits will equal to 2.

Initially the polluting firms have been alloted 6 permits.

Marginal benefit from the 6th permit to the polluting firms is 5 (105-100). Whereas the victims bear a cost of 60 (210-150) due to the 6th permit. Hence the 6th permit is valued at 5 and 60 respectively by polluters and victims.

Hence the victims can pay polluters to give up their 6th permit, as polluters will agree for anything more than 5 and victims for anything less than 60.

5th Permit: Polluters = 10; Victims = 50

4th Permit: Polluters = 15; Victims = 40

3rd Permit: Polluters = 20; Victims = 30

2nd Permit: Polluters = 25; Victims = 20

At this victims value permit less than polluters hence will not pay to buy permit from polluters.

Hence victims will buy 4 permits from polluters.

B.)

The number of permits will equal to 2.

Initially the victims have been alloted 6 permits.

Marginal benefit from the 1st permit to the polluting firms is 30 (30-0). Whereas the victims bear a cost of 10 (10-0) due to the 1st permit. Hence the 1st permit is valued at 30 and 10 respectively by polluters and victims.

Hence the polluters can give victims upto 30 to get their 1st permit, and victims will agree for anything more than 10.

2nd Permit: Polluters = 25; Victims = 20

3rd Permit: Polluters = 20; Victims = 30

3rd Permit: Polluters = 20; Victims = 30

At this victims value permit more than polluters hence will not sell permit to polluters.

C.) The above example is a classic example of Coase theorem. The Govt. can regulate pollution in other ways too:

Imposition of tax on firms based on the pollution caused by the firms.

Regulation which fixes the total permissible limit of pollution.

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