Question

Suppose the government wants to reduce the total pollution emitted by three firms. Currently, each firm is creating 4 tons of pollution, for a total of 12 tons. The government is considering the following two methods to reduce total pollution to 6 tons:

1.	The government sets regulation specifying that each of the three firms must cut its pollution in half.
2.	The government allocates two tradable pollution permits to each of the three firms. Each permit allows the firm to emit 1 ton of pollution. Assume the negotiation and exchange of permits are costless.

The following table shows the cost each firm faces to eliminate each unit of pollution.

	Firm X	Firm Y	Firm Z
Cost of Eliminating:
First ton of pollution	$950	$280	$600
Second ton of pollution	$1,650	$300	$720
Third ton of pollution	$2,500	$350	$880
Fourth ton of pollution	$3,550	$450	$1,050

Suppose the owners of the three firms get together and agree on a trading price of $800 per permit.

Complete the following table with the action each firm will take at this permit price and the amount of pollution each firm will eliminate.

Firm	Initial Pollution Permit Allocation	Action	Final Amount of Pollution Eliminated
	(Tons of pollution)		(Tons of pollution)
Firm X	2
Firm Y	2
Firm Z	2

Determine the total cost of eliminating 6 tons of pollution under each method, and enter the amounts in the following table.

Method	Total Cost of Eliminating 6 Tons of Pollution
	(Dollars)
Regulation
Tradable pollution permits

In this case, using tradable pollution permits reduces 6 tons of pollution at   using regulation.

Answer 1

Every Firm will eliminate the pollution until the cost of eliminating is lower than the cost of permit.

Hence Firm A will not eliminate any pollution as cost is higher than the permit cost, he will prefer to buy 2 more permits from other Firm

Firm B will eliminate 4 tons of pollution as cost is lower for elimination hence will not require permit and thus sell his 2 permits to firm A

Firm C will eliminate 2 tons as after that cost is higher than the permit cost.

Firm A Action - Eliminate 2 tons and purchase 2 permits, Total tons eliminated 0

Firm B Action- Eliminate 4 tons and sell 2 permits, Total tons eliminated 4

Firm C Action - Eliminate 2 tons, Total Tons eliminated 2

If the government would have regulated then each firm would have to eliminate 2 tons each hence the cost would have been = 950+1650 + 280+300+600+720=4500

While with tradable permits cost is =280+300+350+450+600+720=2700