Each firm faces different costs, so reducing pollution is more difficult for som

ID: 1104574 • Letter: E

Question

Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces t eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive. Cost of Eliminating the... Second Unit of Pollution (Dollars) 70 800 125 First Unit of Pollution Third Unit of Pollution Firm Firm X Firm Y Firm Z (Dollars) (Dollars) 110 1,500 180 650 90 Now, imagine that two government employees proposed alternative plans for reducing pollution by 6 units Method 1t Regulation The first government employee suggests limiting pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units. Complete the following table with the total cost to each firm of reducing its pollution by 2 units Total Cost of Eliminating Two Units of Pollution (Dollars) Firm Firm X Firm Y Firm Z Method 2: Tradable Permits Meanwhile, the other employee proposes using a different strategy to achieve the government's goal of reducing pollution in the area from 12 units to 6 units. This employee suggests that the government issue two pollution permits to each firm. For each permit a firm has in 1 unit of pollution. Firms are free to trade pollution permits with one another (that is, buy and sell them) as long as both firms can For example, i firm X agrees to sell a permit to firm Y at an agreed-upon price, then firm Y would end up with three its possession, it can emit agree on a price. its pollution by only 1 unit while frm X would end up with only one permit and would have to reduce its pollution by 3 units. Assume th

Explanation / Answer

Regulation:

Firm X: 55 + 70 = 125

Firm Y: 650 + 800 = 1450

Firm Z: 90 + 125 = 215

Tradable Permits:

Cost of eliminating 3rd unit of pollution by X and Z is $ 110 and $ 180, so if Firm Y offers price greater than $ 180 then both firm will agree to eliminate their 3rd unit of pollution. So, prices at which X and Z will sell their permits is:

1) $ 367

2) $ 384

At price of $ 129, only firm X will sell the permit because its cost of eliminating 3rd unit of pollution is less than the set price.

Firm

Initial Pollution Permits Allocation

Action

Final Amout of pollution eliminated

Cost of pollution reduction

Firm X

Sell one permit

3 units

55 + 70+110 = 235

Firm Y

Buy one permit

1 unit

650

Firm Z

Don't buy/sell

2 unit

90 + 125 = 215

Regulation Versus Tradable Permits:

Proposed Method

Total cost of eliminating six units of pollution

Regulation

125 + 1450 + 215 = 1790

Tradable Permits

235 + 650 + 215 = 1100

Less costly when government distribute Tradable permits.