A tradable permit system can be used to limit land development and promote habit

Question

A tradable permit system can be used to limit land development and promote habitat protection and wildlife preservation. Suppose that on the island of Greenonia there are 10,000 hectares of land. Each of 100 private landowners, owns 100 hectares of land. Right now all of the land is undeveloped, but there has recently been a big increase in the demand for second homes (development) on the island, and the owners are deciding whether to develop their land. Each owner has a demand for developing the land as shown below, where hd is hectares of land developed by the landowner and p is the price (or marginal benefit) per hectare developed.

hd = 100 - 2.5p

To promote habitat protection on the island, the Greenonian government has decided that

4,000 hectares must be set aside and preserved. The remaining 6,000 hectares will be

available for development. The Greenonian government will issue 6,000 development

permits (one permit allowing one hectare to be developed). Suppose that the 6000

development permits are initially divided into lots of 100 permits each. Then 60 of these

lots are issued on a first come first serve basis to 60 landowners. These 60 landowners get

100 permits each. The other 40 get no permits at all. Once the initial issuance is

complete, landowners are allowed to buy or sell as many permits as they wish. Will there

be trading? Explain why, or why not? What will the equilibrium price per permit be?

What will the after-trade allocation of permits be? How much revenue could the

government have obtained if it had auctioned off the permits instead of giving them

away?

Explanation / Answer

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