Question

3. Correcting for negative externalities - Regulation versus tradablepermits 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. Cost of Eliminating the... Second Unit of Pollution (Dollars) 120 First Unit of Pollution (Dollars) 95 Firm Third Unit of Pollution (Dollars) 200 Firm X Firm Y 450 800 1,050 150 Firm z 80 100 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.

Answer 1

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

At 178 & 186 Firm Z will sell permit

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

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

Blank : More