5. Correcting for negative externalities - Regulation versus tradable permits Su

Question

5. Correcting for negative externalities - Regulation versus tradable permits Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods Available Methods to Reduce Pollution 1. The government sets pollution standards using regulation 2. The government allocates tradable pollution permits. 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 to 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. Search the web and Windows

Explanation / Answer

Ans:

1) Computation of total cost of eliminating two units of pollution(dollars)

Firm X = 130 + 165

= 295

Firm Y = 90 + 115

= 205

Firm Z = 600 + 750

= 1350

2) $212 , $219

Since the cost of elimination of 3rd unit of pollution for X is $220 and Y is $140, X will agree to trade a permit at a price above $220 and Y at a price above $140. Hence the price range at which firm Y is willing to sell one of its permit to Z and firm X will not is $141 to $219.

3) Table

4) Total cost of eliminating six units of pollution

Regulation = $295 + $205 + $1350

= $1850

Tradable permits =$295 + $345 + $600

= $1240

5) Less

we can conclude that eliminating pollution is Less costly to society using tradable permits than regulation.

Firm Initial pollution permit Allocation Action Final Amount of pollution eliminated Cost of pollution reduction X 2 No Action 2 units $295 Y 2 Sell one permit 3 units $345 Z 2 Buy one permit 1 unit $600

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