Question

Attempts Average: 75 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 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

Answer 1

regulation

Firm	total cost of elimination of two units
X	80+100	180
Y	450+800	1250
Z	95+120	215

Tradable permits

MCQ ; option D & E

both X & Z are willing to sell it's permit , then they will have to abate one extra unit, so each have to abate extra third unit , so they will sell permit if, permit price is above the cost of 3rd unit of abatement.

So X will sell one permit if permit price is above 150

& Y will sell if it's price is above 200,

So both will sell if price of permit is above 200

permit price = 182

At this price, only X will sell it's permit to Y,

Z will not sell any permit

Firm	initial permits	Action	final amount of pollution eliminated	cost of pollution reduction
X	2	sell one permit	3	80+100+150 = 330
Y	2	buy one permit	2	450
Z	2	no buy/sell	1	95+120 = 215

Method	total cost
Regulation	180+1250+215 = 1645
Permits	330+450+215 = 995

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eliminating pollution is more costly to society when regulation