Question

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:

The actions that can be taken in the third part are: buy one or two permits, sell one or twon permits, dont buy/sell

Answer 1

Method 1 of reducing pollution by regulation where every firm is required to decrease their pollution units by 2 Total cost of reducing 2 units of pollution by three firms is the summation of cost of eliminating the first unit of pollution and second unit of pollution is as calculated below Firm Firm X Firm Y Firm Z Total Cost Total Cost 80+100-180 450+800-1250 95+120 215 1645 Method 2- Tradable Permit Following is the table which specifies whether firm X, Firm Z and both the firms accepts to sell the tradable permit to Firnm Firm X sells the tradable permit if the price is greater than $150, which is its cost of reducing the third unit of pollution. There are two permits given to Firm X. Anyhow, they have to reduce the pollution by two units. Further, decrease in pollution units depends on the price of tradable permits set. Firm Z sells the tradable permit if the price is greater than S200, which is its cost of reducing the third unit of pollution. Firm Y buys the pollution permit if the price of tradable permit is less than $800. This is the cost of eliminating the second pollution units

Price 102 164 179 410 708 Firm X No Yes Yes Yes Yes Firm Z No No No Yes Yes Both No No No Yes Yes The price of the tradable permit is set at $182. At this price, Firm X agrees to sell the tradable permit as its cost of reducing the third unit of pollution $150 is lower than $182 Firm Z does not agree to sell the tradable permit as its cost of reducing the third unit of pollution S200 is lower than the price $182 Firm Y agrees to purchase the tradable permit at $182 as the cost of eliminating the second unit of pollution is $800 is lower than the pollution permit. Firm Initial Pollution Permit Allocation 2 2 2 Action Final Amount Cost of Pollution of Pollution Reduction Eliminated Firm X Firm Y Firm Z Total Cost in eliminating pollution Sell one permit ;3 Buy one permit 1 No action 80+100+150-330 450 95+120 215 995 2 The total cost in reducing pollution through regulation is S1645. The total cost in reducing pollution through tradable permit is S995 Thus, it is less costly when the government distributes tradable permits than when the firm regulate the pollution elimination.