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:

	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.

Firm	Cost of Eliminating the...
	First Unit of Pollution	Second Unit of Pollution	Third Unit of Pollution
	(Dollars)	(Dollars)	(Dollars)
Firm X	80	130	210
Firm Y	550	700	1,075
Firm Z	75	90	130

Now, imagine that two government employees proposed alternative plans for reducing pollution by 6 units.

PART B:

Suppose the the government has set the trading price of a permit at $147 per permit.

Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it costs each firm to reduce pollution to the necessary level. If a firm is willing to buy two permits, assume that it buys one permit from each of the other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.)

Firm	Initial Pollution Permit Allocation	Action (Buy 1, Buy 2, Sell 1, Sell 2, No Action)	Final Amount of Pollution Eliminated	Cost of Pollution Reduction
	(Units of pollution)		(Units of pollution)	(Dollars)
Firm X	2
Firm Y	2
Firm Z	2

Regulation Versus Tradable Permits

Determine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this table.)

Proposed Method	Total Cost of Eliminating Six Units of Pollution
	(Dollars)
Regulation
Tradable Permits

In this case, you can conclude that eliminating pollution is __less/more___ costly to society when the government regulates each firm to eliminate a certain amount of pollution than when it allocates pollution permits that can be bought and sold.

Answer 1

Ans:

Part A)

Calculation of cost of eliminating two units of pollution by each firm.

Firm X = $80 + $130

= $210

Firm Y = $550 + $700

= $1250

Firm Z = $75 + $90

= $165  

Part B)

When the permit price is $147 per permit both firm X and firm Z will sell a permit to firm Y.

Firm	Initial pollution permit allocation	Action	Final amount of pollution eliminated	Cost of pollution reduction
X	2	Sell 1	1	$80
Y	2	Buy 2	0	-
Z	2	Sell 1	1	$75

Part C) Total cost of eliminating six units of pollution

Regulation = $210 + $1250 + $165

= $1625

Tradable permits = $80 + $75

= $155

Part D)

more

we can conclude that eliminating pollution is more costly to society when the government regulates each firm to eliminate a certain amount of pollution.