Question

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. First Unit of Pollution (Dollars) Cost of Eliminating the... Second Unit of Pollution (Dollars) Firm Firm X 70 800 Third Unit of Pollution (Dollars) 110 1,500 180 Firm Y Firm z 125 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.

the last fill in the blank

(less/more)

Answer 1

Method 1 Regulation

Firm X = 55+70 = 125

Firm Y= 650+800 = 1450

Firm Z = 90+125 = 215

Method 2 Tradable permits

As both X and Z are willing so select 367 and 384

Firm	Initial permit	Action	Final Amount	Cost of reduction
X	2	Sell 1 permit	3	55+70+110 = 235
Y	2	Buy 1 permit	1	650
Z	2	Don't buy/sell	2	90+125 = 215

Regulation vs Tradable permits

Regulation= 125+1450+215 = 1790

Tradable permits = 235+650+215 = 1100

In this case you can conclude that eliminating pollution is less costly to society when the government distributes tradable permits