6. Correcting for negative externalities Regulation versus tradable permits Aa A

Question

6. Correcting for negative externalities Regulation versus tradable permits Aa Aa Suppose the government wants to reduce the total pollution emitted by three firms in its area. Currently, each firm is creating4 units of pollution in the area, for a total of 12 pollution units. The government wants to reduce total pollution in the area to 6 units. In order to do so, the government can choose between the following two methods Method 1: The government sets pollution standards Method 2: The government allocates tradable pollution permits Compare the two methods to determine the least-cost way of achieving the desired pollution quantity Eliminating pollution can be more difficult (and thus more costly) for some kinds of firms than for others. The following table shows the cost of eliminating each unit of pollution for each of the three firms Cost of eliminating the first unit of pollution Cost of eliminating the second unit of pollution Cost of eliminating the third unit of pollution Cost of eliminating the fourth unit of pollution Firm X $55 $70 $110 $770 Firm Y $650 $800 $1,500 $7,500 Firm Z $90 $125 $180 $1,080 Under method 1, the government sets pollution standards so that each firm must reduce its pollution by 2 units. Fill in the following table with the total cost to each firm of reducing its pollution by this amount. Firm X Firm Y Firm Z Total cost of eliminating 2 units of pollution $125 Adding up the costs to the three firms, you can see that $165 standards is st of eliminating 6 units of pollution through regulatory $180 $70

Explanation / Answer

Ans:

1) Computation of cost of elimination of two units of pollution(In dollars)

X = 55 + 70

= 125

Y = 650 + 800

= 1450

Z= 90 + 125

= 215

The total cost of eliminating 6 units of pollution = 125 + 1450 +215

= 1790

2) The cost of elimination of 3rd unit of pollution for firm X is $110 and firm Z is $180. Hence firm X and Z will trade a permit for a price which is above $180.

Following will apply - $400 , $365

3) If the permit price is $420 per permit, both firm X and firm Z will sell a permit to firm Y.

Total cost of eliminating 6 units of pollution using tradable permits = $245 + $395

= $640

3) More

Eliminating pollution through regulation is more costly to society than tradable permits.

Particulars Firm X Firm Y Firm Z Initial pollution permit allocation 2 units 2 units 2 units Action Sell one permit Buy two permits Sell one permit Final pollution amount 1 unit 4 units 1 unit Cost of pollution reduction 55+70+110 = 245 0 90+125+180 =395

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