5. Correcting for negative externalities- Regulation versus tradable permits Sup
ID: 1110566 • Letter: 5
Question
5. Correcting for negative externalities- Regulation versus tradable permits Suppose th·government wants to reduce the total polation area, for a total of emitted by three local firms. Currenty, each firm is creating 4 unts of pollution the wants to reduce total polution in the area to 6 units, it can choose between the following two 2 pellution units. If the government methods: Available Methods to Reduce Pollution 1. The government sets pollution standards unsing regulation 2. The government allocates tradable pollution permit. s more difficult for some fems than others. The following table shows the cost each firm faces to Each fem faces different costs, so reducing polution i elminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, elminating all 4 units of poilution) is prohábitively expensive Cost of Eliminating the… First Unit of Pollution Second Unit of Pollution Third Unit of Pollution (Dollars) (Dellars) (Dallars) irns X 75 100 120 Firne 2 1,100 Non, magine that two government employees proposed t alternative plans for redacing pollution by 6 unts. Method l: Regulation through regulation. To meet the poilution goal, the government requires each firm to The fest government employee sugpests iating pollution reduce its pollution by 2 unts. Complete the folowing table with the total cont to each fem of reducing ets polution by 2 unts Total Cost of Eliminating Two Units od Pollution Frm2 Method 2: Tradable Permits Heanwhle, the other empoyee proposes u ning a different strategy to achieve the govenment's goal of reduoing pollution in the area from 12 unts to each firm. For each permit a fem has in its possession, e can ent 6 unsts. Ths employee suggests that the govenment inssun two pollution permts t For example, dfem × agrees to sea· m" eo firm at an agreed-upon price, the. Im vold end up and exchange of permits ace costless because firm 2 has high pellution reduction csts, thinks t might be better off buying a permit from frm Y and a permi from frm X so that e of poilution. Fems are free to trade pollution permits with one another (that is, buy and sell them) as long as both fms can agree on aprice permits and wodd need to reducae shde fem X would end up with only one permt and would have to reduce es pollution by 3 unets. Assume the negotiation 't have to reduce its own pohtion emmons. At ech of the folomng prees ishmrmhng to sell ofits permits tofm 2, but nnn xExplanation / Answer
Regulation:
Firm X: 75 + 100 = 175
Firm Y: 60 + 80 = 140
Firm Z: 500 + 675 = 1175
Tradable Permits:
Cost of eliminating 3rd unit of pollution by X and Y is $ 160 and $ 120, so if Firm Z offers price greater than $ 120 but less than $ 160 then firm Y will sell but X will not. So, prices at which Y will sell but X will not is:
1) $ 131
2) $ 144
At price of $ 482, both firms will sell the permit because their 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
2
Sell one permit
3 units
75 + 100 + 160 = 335
Firm Y
2
Sell 1 permit
3 unit
60 + 80 +120 = 260
Firm Z
2
Buy 2 permits
0 unit
0
Regulation Versus Tradable Permits:
Proposed Method
Total cost of eliminating six units of pollution
Regulation
175 + 140 + 1175 = 1490
Tradable Permits
335 + 260 + 0 = 595
Less costly when government distribute Tradable permits.
Firm
Initial Pollution Permits Allocation
Action
Final Amout of pollution eliminated
Cost of pollution reduction
Firm X
2
Sell one permit
3 units
75 + 100 + 160 = 335
Firm Y
2
Sell 1 permit
3 unit
60 + 80 +120 = 260
Firm Z
2
Buy 2 permits
0 unit
0
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