Question

There are three industrial firms in Happy Valley. Firm Initial Pollution Cost of Reducing Level Pollution by 1 Unit _______________________________________________________ A 100 units $60 B 80 units $50 C 60 units $40 The government wants to reduce pollution to 150 units, so it gives each firm 50 tradable pollution permits. Each permit allows for 1 unit of pollution. a. Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation? b. How much higher would the costs of pollution reduction be if the permits could not be traded?

Answer 1

Firm	Initial Pollution Level	Cost for Reduction of Pollution Level.
A	100 units	$60
B	80 units	$50
C	60 units	$40

A)

Highest cost for reduction of pollution by 1 units is of Firm A. Hence he will keep its own permits and buy 50 permits from the other firms. Here firm A can pollute up to the level mentioned by the government i.e. 150 units.

Second highest cost of pollution reduction is for firm B and this firm will also not sell its permit because of high cost.

Hence Firm C will sell its 50 permit to firm A due to the least cost of pollution reduction. Here firm has to incurred only $40 to reduce pollution and receive $60 from trade of pollution permit.

In that case Firm A will not reduce its pollution level.

However firm B will reduce pollution level by 30 units ( 80 - 50 ) and total cost for that reduction is (30 units @50 ) $1500.

Firm C will also reduce its pollution level by 60 units and total cost of that reduction is (60 units @40) $2400

(Since firm C sell its 50 permit to firm A and now firm has to reduce pollution to zero level because maximum permissible limit is only 50 units. Hence cost is calculated for all 60 units.)

The total cost reduction in pollution is $3900

B) If the permit is not trade able then total cost of the reduction of pollution

Firm A = 50 units ( 100 - 50 ) @60 = $3000

Firm B = 30 units ( 80 - 50 ) @ 50 = $1500

Firm C = 10 units ( 60 - 50 ) @40 = $400

Total cost = ( 3000 + 1500 + 400 ) = $4900

If permit are not traded then higher $1000 ( 4900 - 3900 ) is incurred.