Question

correcting for negative externalities-regulation versus tradable permits

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) Firm Cost of Eliminating the... Second Unit of Pollution (Dollars) 100 800 120 Firm X Third Unit of Pollution (Dollars) 150 1,050 200 Firm Firm z 95

Answer 1

Firm	TC of eliminating two units of pollution
Firm X	80+100 =180
Firm Y	450+800=1250
Firm Z	95+120=215

At 410 & 708 Firm X and Z will sell permit

Firm	Initial poll permits	Action	Final amount	Cost
Firm X	2	Sell one permits	3	80+100+150=330
Firm Y	2	Buy two permits	0	0
Firm Z	2	Sell one permits	3	95+120+200=415

Proposed method	TC
Regulation	180+1250+215=1645
Tradeable permits	330+415=745

Blank : Less