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 two methods: Under method 1, the governments sets pollution standards, whereas under method 2, the government allocated tradable pollution permits, Let’s 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 it is for others. The table below shows the cost of eliminating each unit of pollution for each of the three firms.

Cost of eliminating the first unit of pollution $130 (firm x), $90 (firm y), $600 (firm z)
Cost of eliminating the second unit of pollution $165 (firm x), $115 (firm y), $750 (firm z)
Cost of eliminating the third unit of pollution $220 (firm x), $140 (firm y), $1,200 (firm z)

Assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive.

In order to regulate pollution, suppose the government sets pollution standards so that each firm must reduce its pollution by 2 units. Fill in the table below with the total cost to each firm of reducing its pollution by this amount.

Total cost of eliminating 2 units of pollution
Firm X
a) $165
b) $385
c) $295
d) $350

Firm Y
a) $255
b) $115
c) $230
d) $205

Firm Z
a) $1,350
b) $1,800
c) $750
d) $1,950

Adding up the costs to the three firms, you can see that the total cost of eliminating 6 units of pollution through standards of regulation is ________________
a) $1,850
b) $1,645
c) $1,490
d) $2,590

Now suppose the government decides to use a different strategy to achieve its goal of reducing the pollution in the area from 12 units to 6 units – namely, it issues two pollution permits to each firm. For each permit a firm has in its possession, it can emit 1 unit of pollution. Firms are free to trade pollution permits with one another – that is, buy and sell them – as long as both firms can agree on a price. For example, if firm X and firm Y were able to agree on a suitable price for a permit, firm Y would end up with three permits and would only need to reduce its pollution by 1 unit, whereas firm X would end up with only one permit and would have to reduce its pollution by 3 units. Assume the negotiation and exchange of permits is costless.

Because of its high pollution – reduction costs, firm X thinks it might be better off buying permits from firm Y and firm Z so that it doesn’t have to reduce its own pollution emissions. At which of the following prices is only firm Y willing to sell one of its permits to firm X, while firm Z will decline to do so? Check all that apply.
a) $100
b) $410
c) $5180
d) $195

Again, suppose that you are considering the method of pollution reduction involving tradable permits. Suppose the owners of the three firms get together and agree on a trading price of $415 per permit. Fill in the following table with the amount each firm will pollute and the amount it costs each firm to reduce pollution to the necessary level (Hint: Do not include the prices of permits in the cost of reducing pollution)

Initial pollution permit allocation = 2 units (firm X), 2 units (firm Y), 2 units (firm Z)
Trades firm X __________ trades firm Y_______ trades firm Z
Final pollution amount firm X ________ firm Y _________ firm Z___________
Cost of reducing pollution to final amount firm X __________ firm Y _______ firm Z__________

Given this scenario, the total cost of eliminating 6 units of pollution using a tradable permit system is ___________
a) $0
b) $860
c) $1,690
d) $1,240

Based on this example, you can conclude that eliminating pollution is _________
a) more
b) less
costly to society when the government directs each firm to eliminate a certain amount of pollution than when it allocates pollution permits that can be bought and sold.

Answer 1

Cost of eliminating two units of pollution

Firm X = $130 + $165 = $295

Firm Y = $90 + $115 = $205

Firm Z = $600 + $750 = $1350

Cost of eliminating 6 units of pollution through regulatory standards is $295 + $205 + $1350 = $1850

If both the firms sell one of their permits then they both will have to reduce their pollution by 3 units.

Cost for firm X to reduce the third unit of pollution = $220

Cost for firm Y to reduce the third unit of pollution = $140

Total cost = $360 And 360/2 per firm

So the firm X & Y will sell their permit with a price of $190

	Firm X	Firm Y	Firm Z
Initial pollution permit allocation	2	2	2
Action	Sells one permit to Firm Z	Sells one permit to Firm Z	Buys one permit each from Firm X and Firm Y
Final pollution amount	1	1	4
Cost of pollution reduction	515	345	830

The total cost of eliminating 6 units of pollution using a tradable permit system is $515 + $345 + $830 = $1690.

Eliminating pollution is more costly to society when the government directs each firm to eliminate a certain amount of pollution than when it allocates pollution permits that can be bought and sold.

Answer 2

Dear Student, please refer to the question below.
Question:

5. Correcting for negative externalities Regulation versus tradablepermits 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 Cost of Eliminating the... First Unit of Pollution Second Unit of Pollution Third Unit of Pollution (Dollars) 100 80 675 Dollars 75 60 500 (Dollars) 160 120 1,100 Firm X Firm Y Firm Z 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 units Complete the following table with the total cost to each firm of reducing its pollution by 2 units Total Cost of Eliminating Two Units of Pollution Dollars Firm Firm X Firm Y Firm Z

ANS: