Two plants are emitting a uniformly mixed pollutant called gunk into the beautif

ID: 1213731 • Letter: T

Question

Two plants are emitting a uniformly mixed pollutant called gunk into the beautiful sky over Tourist Town. The city government decides it can tolerate total emissions of no more than 100 kg of gunk per day. Plant G has marginal reduction costs of 100 - 4x and is currently polluting at a level of 25, while plant K has marginal reduction costs of 150 - y and currently pollutes at a level of 150 (x and y are the level of emissions at each plant).

1. What is the cost-effective pollution level for each plant if total pollution must equal 100? Suppose the city government knows marginal reduction costs at the two plants. In this case, could the city obtain cost-effective pollution reduction using a CAC approach? If so, how?

2. In reality, why might the city have a hard time getting this information? What are the two “incentive-based” policies that could be used to get a cost effective reduction of pollution to 100 units, without knowing the MC of the two firms? Be specific. Discuss two advantages each method has over the other.

3. Suppose the authorities are considering either a tradeable emission permit system, in which they give half the permits to each firm, or a tax system. If both systems work perfectly, how much will the firms have to pay, in total, for pollution reduction under the two schemes? (assume permits are bought and sold by firms at a price equal to the tax.) Could this explain why Tourist Town would be more likely to adopt a permit giveaway system?

4. Several theoretical studies have shown that incentive-based policies might generate huge cost savings, and the IB approach could be as much as 22 times cheaper than the CAC approach. Discuss at least three reasons why Tourist Town might not get such substantial savings in moving from CAC regulation to a marketable permit system.

5. Suppose the marginal benefits of pollution reduction in Tourist Town are constant and equal to $64. (Each unit of pollution reduction brings in one more tourist, who spends $64.) Is 100 units of pollution obtained cost-effectively, an efficient level? If not, will efficiency be achieved through more or less pollution? Why?

Explanation / Answer

Answer:

There are two ways to answer this one, an easy way and a hard way. The easy way is to use a little algebra. We know two things:

x + y = 100 (total pollution equals 100)

100 - 4x = 150 - y (marginal reduction costs at both plants are equal)

The second condition must hold for the solution to be cost-effective. One can now solve for the two unknowns, x and y. The result is x = 10, y = 90.

The cost of pollution reduction is plant specific, and is probably known (roughly) only by the plant's engineers and managers. The city council could impose a pollution tax (charge) equal to $60 per Kg; or it could issue 100 marketable permits. At a tax of $60, plant G would cut back to 10 units of pollution, since for units 25 to 10, cutting back is cheaper than paying the tax. Below 10 units however, the firm would rather pay the tax than cut back. For similar reasons, plant K would cut back to 90 units.

If 100 permits were issued, the two plants would have an incentive to buy and sell them until plant G wound up with 10 permits, and plant K 90.

Disadvantages of taxes over permits: the regulators would not know where exactly to set the tax to get at most 100 units of pollution. The tax would have to be imposed, than adjusted. In addition, firms bear a higher cost.

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Two plants are emitting a uniformly mixed pollutant called gunk into the beautif

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Two plants are emitting a uniformly mixed pollutant called gunk into the beautif

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