5. The two dry-cleaning companies in Golden, College Cleaners and Big Green Clea

Question

5. The two dry-cleaning companies in Golden, College Cleaners and Big Green Cleaners, are a major source of air pollution. Together they currently produce 350 units of air pollution, which the town wants to reduce to 200 units. The accompanying table shows the current pollution level produced by each company and each company’s marginal cost of reducing its pollution. The marginal cost is constant.

Company

Initial Pollution Level (units)

Marginal cost of reducing pollution (per unit)

College Cleaners

230

$5

Big Green Cleaners

120

$2

a. Suppose that Golden passes an environmental standards law that limits each company to 100 units of pollution. What would be the total cost to the two companies of each reducing its pollution emissions to 100 units?

Suppose instead that Golden issues 100 pollution vouchers to each company, each entitling the company to one unit of pollution, and that these vouchers can be traded.

b. How much is each pollution voucher worth to College Cleaners? to Big Green Cleaners? (That is, how much would each company, at most, be willing to pay for one more voucher?)

c. Who will sell vouchers and who will buy them? How many vouchers will be traded?

d. What is the total cost to the two companies of the pollution controls under this voucher system?

Company

Initial Pollution Level (units)

Marginal cost of reducing pollution (per unit)

College Cleaners

230

$5

Big Green Cleaners

120

$2

Explanation / Answer

a) Marginal Cost of reducing pollution for College Cleaners = $5 & for Big green Cleaners = $2

Under perfect competition, Marginal cost equals to average cost

thus, total cost of reducing pollution upto 100 units for College Cleaners = $5 * (230-100) = $650

Also total cost of reducing pollution upto 100 units for Big Green Cleaners = $2 * (120-100) = $40

thus, total Cost of reducing pollution for both College Cleaners and Big green Cleaners = $650 + $40 = $690

b) Again here Golden issues 100 vouchers to both College Cleaners and Big Green Cleaners and also given 1 voucher = 1 unit of pollution

Thus in this condition, marginal cost = Average Cost i.e., cost of producing 1 unit of pollution

Thus for College Cleaners, Average Cost = $ 5 which means worth of 1 unit of voucher = $ 5

Similarly worth of 1 unit of voucher given to Big Green Cleaners = $ 2

c) As vouchers are issued to both college Cleaners and Big Green Cleaners and they can be traded as well both College Cleaners and Big Green Cleaners will sell these vouchers to Golden and total 200 vouchers will be traded.

d) Under new voucher system, each company can produce just 100 units of pollution therefore, their total cost of production = 100 *( Average cost of pollution of College Cleaners + average cost of pollution of Big Green Cleaners) = 100 * ($5+$2)= $700

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