Question

3. Two pink slime producers, XL and IPSP, are located in an otherwise pastoral mountain town. Each producer emits 30 tons of ammonium hydroxide into the atmosphere each year. City planners wish to cut the level of ammonium hydroxide pollution to 50 tons overall.

a. Alfred B. Packer steps forward with the following suggestion. “Make each firm cut emissions by 5 tons. That seems fair, doesn’t it?” Do you agree? Explain your answer.

b. Suppose that XL and IPSP are both capable of reducing emissions by 5 tons, but that it costs XL $50, and IPSP $100, to clean up each ton of emissions. Comment on the fairness of Packer’s proposal in light of this additional information.

c. If you were the “King of the World” and hoped to clean up the ammonium hydroxide at the lowest possible cost, how would you split the burden of the cleanup between XL and IPSP?

d. Suppose the city goes to a tradable permits system for reducing ammonium hydroxide emissions. It prints 50 permits, each of which gives the bearer the right to emit 1 ton of ammonium hydroxide. It then distributes 25 permits each to XL and IPSP, and informs both that they are free to buy and sell the permits to each other.

i. When permits are traded, who will be the likely buyer of permits, and who will be the likely seller? Explain.

ii. What is the lowest price that you expect pollution permits to sell for?

iii. What is the highest price you expect pollution permits to sell for?

vi. When trade is complete, how many permits do you expect to see sold?

v. Under the tradable permits system, how much of the cleanup does XL end up being responsible for? How does this outcome compare to your answer to (c)?

Answer 1

Answer:

(a) Yes,suggestion seems fair. I agree with it. Each firm is producing 30 tons of emission and they should cut 5 tons of emission each.

(b) Keeping in view the additional information, although it seems fair from the point of firm XL to reduce 5 tons of emission but reducing 5 tons of emission by each firm will increase the social cost of reducing emission as compared to some other way where cost of reducing 10 tons of emission will be lowest to the society.

(c) If I were the King then I would suggest that XL should reduce all 10 tons because it will cost minimum to reduce emission(10*$50=$500). Whereas IPSP should compensate XL for extra cost incurred for reducing emission.

(d)

(i) When permits are traded IPSP will be the likely buyer of the permits, and XL will be the likely seller. Cost of reducing emission is less for XL so it would prefer to reduce emission if it gets higher price of permit compared to it's emission reduction cost of $50.

(ii) Lowest Price at which pollution permit could be sold is $51. It will give XL benefit of $1 per permit sold and Gain to IPSP will be $49.

(iii) Highest Price at which pollution permit could be sold is $99. It will give XL benefit of $49 per permit sold and gain to IPSP will be $1.

(iv) When trade is complete all permits are sold because cost of reducing emission is constant for alll units of emission reduced.

(v) Under the tradeable permits system, XL end up being responsible for 10 tons of cleanup. This is the same outcome as in answer to (c).