If responding in pencil please write clearly. I beg. 5. Correcting for negative

ID: 1161397 • Letter: I

Question

If responding in pencil please write clearly. I beg. 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 in the area, for a total of 12 pollution units. If the government wants to reduce total nollution 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 requlation 2. The governmment allocates tradable pollution permits Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table etiminate each unit of pollution. For each frm, assume that the cost of reducing poliution to zero (that is, eliminating all 4 units of prohibitively expensive Cost of Eliminating the... Second Unit of Pollution (Dollars) 125 70 800 First Unit of Pollution (Dollars) 90 Third Unit of Pollution (Dollars) 180 110 1,500 Firm Firm X Firm Y Firm Z 650

Explanation / Answer

Regulation:

Firm X: 90 + 125 = 215

Firm Y: 55 + 70 = 125

Firm Z: 650 + 800 = 1450

Tradable Permits:

Cost of eliminating 3rd unit of pollution by X and Y is $ 180 and $ 110, so if Firm Z offers price greater than $ 180 then both Firm X and Y will sell their permit. So, prices at which X and Y will sell their permits is:

1) $ 579

2) $ 787

At price of $ 498, both Firm X and Y will sell their permits because its cost of eliminating 3rd unit of pollution is less than the set price.

Firm

Initial Pollution Permits Allocation

Action

Final Amount of pollution eliminated

Cost of pollution reduction

Firm X

Sell one permit

3 units

90 + 125 + 180 = 395

Firm Y

Sell one permits

3 unit

55 + 70 + 110 = 235

Firm Z

Buy two permits

0 unit

Regulation Versus Tradable Permits:

Proposed Method

Total cost of eliminating six units of pollution

Regulation

215 + 125 + 1450 = 1790

Tradable Permits

395 + 235 + 0 = 630

More costly when government regulates each firm to eliminate certain amount of pollution.