Question

The town of Cleanville lies next to a lake, which the residents of the town use for fishing, boating, and other recreational activities. Last year, two firms, Filth Inc. and Sludge Inc., built factories on the other side of the lake and have been dumping trash into it. Although some of the trash will dissipate naturally, the amount of trash the two firms emit is too much for the lake to handle. Right now, each firm dumps 40 pounds of trash in the lake each year (total of 80 pounds). Environmental scientists in Cleanville estimate that the lake can handle only 30 pounds of trash per year. The table below reports the marginal costs to the two firms of reducing trash.
 

Pounds reduced	Filth Inc.’s marginal costs (in $1,000s)	Sludge Inc.’s marginal costs (in $1,000s)
5	2	7
10	4	10
15	6	13
20	8	16
25	10	19
30	12	22
35	14	25
40	16	28

The marginal cost numbers tell us how much it would cost to reduce the marginal five pounds of trash. Therefore, Filth Inc.'s marginal cost of reducing the first 5 pounds is $2,000 and the next 5 pounds $4,000. Therefore, the total cost to reduce 10 pounds is $6,000.

Suppose the city council agrees with the scientists' estimates and orders each firm to reduce trash by 25 pounds. The total cost to reduce this amount of trash is $   .

 

Part 2

Suppose that after taking your economics course you visit Cleanville and hear about the city council's solution to reducing the trash. You think to yourself, “Haven’t these people learned some basic economics and the Coase theorem?" You gather some data, crunch some numbers, and go to the next city council meeting. You tell them that they should give each firm three permits. Each permit allows the firm to emit 5 pounds per year. Each firm can therefore emit 15 pounds per year, which means they would have to reduce the amount of trash they emit by 25 pounds.

One of the council members raises his hand and asks, "But that's what our proposal does. How is yours any different?"
You answer, "What makes my proposal different is that we allow the firms to buy or sell these permits." The city council is amazed at your insight and comments how much you learned in your econ class. They realize that after your proposal has been put into place, the total cost of getting rid of the 50 pounds of trash will fall to $   , the lowest total cost possible.

Part 3

Let’s see how the drop in total costs will come about. Filth Inc. and Sludge Inc. each start with three permits. If a firm does not buy a permit or sell one of its permits, it would need to reduce trash by 25 pounds. If it sells a permit, it would have to get rid of more trash, and if it buys a permit, it would have to get rid of less.
 

Pounds reduced	Filth Inc.’s marginal costs (in $1,000s)	Sludge Inc.’s marginal costs (in $1,000s)
5	2	7
10	4	10
15	6	13
20	8	16
25	10	19
30	12	22
35	14	25
40	16	28

Hector Sludge, the owner of Sludge Inc., calls Jordan Filth and tells her he has an offer she can't refuse (a little trash humor): "I will buy one of your permits for $14,000."

Choose one or more:A.If they trade the permit, Filth Inc. will need to get rid of 20 pounds of trash.B.If they trade the permit, Sludge Inc. will need to get rid of 20 pounds of trash.C.If they trade the permit, Sludge Inc. will need to get rid of 30 pounds of trash.D.Jordan will take the offer, as she would only need to spend $12,000 to get rid of 5 more pounds of trash.E.This is a good deal for Hector because he can save $19,000 by not reducing trash from 20 pounds to 25 pounds.F.If they trade the permit, Filth Inc. will need to get rid of 30 pounds of trash.

Answer 1

The town of Cleanville lies next to a lake, which the residents of the town use for fishing, boating, and other recreational activities. Last year, two firms, Filth Inc. and Sludge Inc., built factories on the other side of the lake and have been dumping trash into it. Although some of the trash will dissipate naturally, the amount of trash the two firms emit is too much for the lake to handle. Right now, each firm dumps 40 pounds of trash in the lake each year (total of 80 pounds). Environmental scientists in Cleanville estimate that the lake can handle only 30 pounds of trash per year. The table below reports the marginal costs to the two firms of reducing trash.
 

Pounds reduced	Filth Inc.’s marginal costs (in $1,000s)	Sludge Inc.’s marginal costs (in $1,000s)
5	2	7
10	4	10
15	6	13
20	8	16
25	10	19
30	12	22
35	14	25
40	16	28

The marginal cost numbers tell us how much it would cost to reduce the marginal five pounds of trash. Therefore, Filth Inc.'s marginal cost of reducing the first 5 pounds is $2,000 and the next 5 pounds $4,000. Therefore, the total cost to reduce 10 pounds is $6,000.

Suppose the city council agrees with the scientists' estimates and orders each firm to reduce trash by 25 pounds. The total cost to reduce this amount of trash is $   .

 

Part 2

Suppose that after taking your economics course you visit Cleanville and hear about the city council's solution to reducing the trash. You think to yourself, “Haven’t these people learned some basic economics and the Coase theorem?" You gather some data, crunch some numbers, and go to the next city council meeting. You tell them that they should give each firm three permits. Each permit allows the firm to emit 5 pounds per year. Each firm can therefore emit 15 pounds per year, which means they would have to reduce the amount of trash they emit by 25 pounds.

One of the council members raises his hand and asks, "But that's what our proposal does. How is yours any different?"
You answer, "What makes my proposal different is that we allow the firms to buy or sell these permits." The city council is amazed at your insight and comments how much you learned in your econ class. They realize that after your proposal has been put into place, the total cost of getting rid of the 50 pounds of trash will fall to $   , the lowest total cost possible.

Part 3

Let’s see how the drop in total costs will come about. Filth Inc. and Sludge Inc. each start with three permits. If a firm does not buy a permit or sell one of its permits, it would need to reduce trash by 25 pounds. If it sells a permit, it would have to get rid of more trash, and if it buys a permit, it would have to get rid of less.
 

Pounds reduced	Filth Inc.’s marginal costs (in $1,000s)	Sludge Inc.’s marginal costs (in $1,000s)
5	2	7
10	4	10
15	6	13
20	8	16
25	10	19
30	12	22
35	14	25
40	16	28

Hector Sludge, the owner of Sludge Inc., calls Jordan Filth and tells her he has an offer she can't refuse (a little trash humor): "I will buy one of your permits for $14,000."

Choose one or more:A.Jordan will take the offer, as she would only need to spend $12,000 to get rid of 5 more pounds of trash.B.If they trade the permit, Sludge Inc. will need to get rid of 20 pounds of trash.C.If they trade the permit, Filth Inc. will need to get rid of 20 pounds of trash.D.If they trade the permit, Sludge Inc. will need to get rid of 30 pounds of trash.E.This is a good deal for Hector because he can save $19,000 by not reducing trash from 20 pounds to 25 pounds.F.If they trade the permit, Filth Inc. will need to get rid of 30 pounds of trash.