Suppose the government wants to reduce the total pollution emitted by three loca
ID: 1144776 • Letter: S
Question
Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the 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 Firm Firm X Firm Y Firm Z First Unit of Pollution (Dollars) 130 90 600 Cost of Eliminating the... Second Unit of Pollution (Dollars) 165 115 750 Third Unit of Pollution (Dollars) 220 140 1,200 Now, imagine that two government employees proposed alternative plans for reducing pollution by 6 units Method 1: 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 unitsExplanation / Answer
Regulation:
Firm X: 130 + 165 = 295
Firm Y: 90 + 115 = 205
Firm Z: 600 + 750 = 1350
Tradable Permits:
Cost of eliminating 3rd unit of pollution by X and Y is $ 220 and $ 140, so if Firm Z offers price greater than $ 140 but less than $ 220 then Y will sell the permit but X will not. So, prices at which X will not but Y will sell their permits is:
1) $ 212
2) $ 219
At price of $ 218, only firm Y will sell the permit because its cost of eliminating 3rd unit of pollution is 140 which is less than the set price.
Firm
Initial Pollution Permits Allocation
Action
Final Amout of pollution eliminated
Cost of pollution reduction
Firm X
2
Don't buy or sell permit
2 units
130 + 165 = 295
Firm Y
2
Sell one permit
3 unit
90 + 115 + 140 = 345
Firm Z
2
Buy 1 permit
1 unit
600
Regulation Versus Tradable Permits:
Proposed Method
Total cost of eliminating six units of pollution
Regulation
295 + 205 + 1350 = 1850
Tradable Permits
295 + 345 + 600 = 1240
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
Don't buy or sell permit
2 units
130 + 165 = 295
Firm Y
2
Sell one permit
3 unit
90 + 115 + 140 = 345
Firm Z
2
Buy 1 permit
1 unit
600
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