Question

There are three industrial firms in Happy Valley.

Firm	Initial Pollution Level	Cost of Reducing Pollution by 1 Unit
	(Units)	(Dollars)
A	30	20
B	40	30
C	20	10

The government wants to reduce pollution by 60 units, so it gives each firm 20 tradable pollution permits.

Because firm   has the highest cost of reducing pollution by 1 unit, it would like to   another firm. Because firm   has the lowest cost of reducing pollution by 1 unit, it is willing to   the firm with the highest cost.

Complete the second column of the following table by indicating who buys and sells permits in this case. Complete the fourth column of the table with the number of permits each firm ends up with after trading with the others. Next, subtract the number of permits from the initial pollution level to determine how many units of pollution reduction each firm has to complete, and enter these values into the fifth column of the table. Next, determine the total cost of reducing the pollution levels you determined in the previous column, and enter that into the final column of the table. Finally, add up the total pollution reduction costs for each firm and enter the total amount in the final cell of the total row in the following table.

Firm	Buys or Sells	Initial Pollution Level	Permits after Trade	Remaining Pollution Reduction	Cost of Reducing Pollution by 1 Unit	Total Pollution Reduction Cost
					(Dollars)	(Dollars)
A		30			20
B		40			30
C		20			10
Total						If permits could not be traded, firm A would have to removeunits of pollution at a total cost of, firm B would have to removeunits of pollution at a total cost of, and firm C would have to removeunits of pollution at a total cost of. The overall cost of reducing pollution in this case is , which is   than with tradable permits.

Answer 1

a) Firm B has the highest cost of eliminating pollution so it would like to buy permit

b) Firm C has the lowest cost of eliminating pollution so it is willing to sell the permit.

If permits could not traded,

Firm A would remove 20 units at a total cost of 20 x 20 = $ 400

Firm B would remove 20 units at a total cost of 20 x 30 = $ 600

Firm C would remove 20 units at a total cost of 20 x 10 = $ 200

Overall cost of reducing pollution = 400 + 600 + 200 = $ 1200

Greater than with tradable permits.