Question

Suppose there are two firms, A and B, that make a mess when they produce. Firm A can clean up “mess” for $10/unit while firm B can only do it for $20/unit. Suppose further that firm A produces 100 units of mess per week while firm B produces 200 units of mess per week. The government decides that there should be no more than 150 units of mess produced per week.

What would the total costs of cleanup be if no firm was allowed to emit more than 75 units of mess per week?

What would the total costs of cleanup be if each firm was ordered to reduce emissions by half?

What would the total costs of cleanup be if each firm was ordered to reduce mess by 75 units?

How much mess would be reduced if the government instead instituted a tax that required firms to pay $15 per unit of mess that they created? How about from a tax of $30 per unit?

Describe what might happen if instead the government issued “marketable mess permits.” However, once you acquire the permit from the government, these rights are not transferable. Each permit would give the holder the right to make one unit of mess per week. If you don’t hold a permit, you are free to produce as long as you clean up your mess. If the government wanted to fully eliminate mess, it would offer 0 permits, however it only wants to reduce mess by ½. Therefore it makes 150 permits available. What is the most that firm A would be willing to pay the government for a permit? Firm B? Suppose the folks at firm A are really good at navigating the red-tape and manage to acquire 100 permits at a price of $5.00 each. That leaves only 50 more permits for Firm B, who will pay $5.00 each as well. What are the total costs of reducing mess in this scenario? How much revenue does this scheme generate for the government?

In thinking about part (e), ask yourself whether there are potential gains to be made from trade. If the government now allows firms to transfer property rights and also ensures all parties that no new permits will be issued, describe the process that would likely take place. What range of prices might these permits trade for on a pollution exchange market? How many units of mess would firm A end up cleaning up? Firm B? What are the total costs of reducing mess in this scenario?

Answer 1

1) The total costs of cleanup be if no firm was allowed to emit more than 75 units of mess per week:

Cost of firm A = (100-75)*10 = $250

Cost of firm B = (200-75)*20 = $2500

Total cost = 2500+250=$2750

2) the total costs of cleanup be if each firm was ordered to reduce emissions by half:

Cost of Firm A = (100*1/2)*10 = $500

Cost of Firm B = (200*1/2)*20 = $2000

total cost = 2000+500=$2500

3) the total costs of cleanup be if each firm was ordered to reduce mess by 75 units:

Cost of firm A = 75*10=$750

Cost of firm B = 75*20=$1500

Total cost = 1500+750=$1250

4) if the government instead instituted a tax that required firms to pay $15 per unit of mess that they created, then firm A will clean all its mess because cleaning 100 units mess by A will cost $1000 but paying fee would be csotlier equal to 15*100=$1500.

on other hand firm B will not clear mess as it is more costly rather than paying tax.

Thus 100 units of mess will be cleared.

If tax is of $30 per unit then both the firms will clear their all mess as it would be les costlier for both than paying tax. Hence total of 100+200 = 300 units of mess will be cleared.

5) As cleaning cost oer unit of mess of firm A is $10 so for most A will pay $1000 for 100 permits or $10 per permits upto for 100 units.

Firm B will at most pay $20 per permit for all 150 permits (or $3000) as ir creates mess more than 150 units.