Suppose the government wants to reduce the total pollution emitted by three firm

Question

Suppose the government wants to reduce the total pollution emitted by three firms in its area. Currently, each firm is creating 4 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 $75 $100 $160 $1,120 Firm Y $60 $80 $120 $600 Firm Z $500 $675 $1,100 $6,600 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 Adding up the costs to the three firms, you can see that the total cost of eliminating 6 units of pollution through regulatory standards is

Explanation / Answer

Ans:

1) The total cost of eliminating two units of pollution

Firm X = $75 + $100

            = $175

Firm Y = $60 + $80

           = $140

Firm Z = $500 + $675

           = $1175

The total cost of eliminating 6 units of pollution using regulatory standards = $175 + $140 + $1175

                                                                                                                       = $1490

2) $150,$145

The cost of eliminating third unit of pollution to firm X is $160 and to firm Y is $120.Hence at a permit price of above $120 and below $160, firm Y will sell a permit to firm Z and firm X will decline to do so.

3) when the permit price is $158 per permit only firm Y will sell a permit firm Z.

The total cost of eliminating 6 units of pollution using tradable permit system = $175 + $260 + $500

                                                                                                                          = $935

4) Less

Eliminating pollution is less costly to society when government allocates pollution permits.   

Particulars Firm X Firm Y Firm Z Initial pollution permit allocation 2 2 2 Action Don't buy / sell sell one permit buy one permit Final pollution amount 2 units 3 units 1 unit cost of pollution reduction $75 + $100 = $175 $60 + $80 + $120 = $260 $500

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