Aplia: Student Question Chegg Study Order Confirmation Chegg.com 5. Environmenta

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Aplia: Student Question Chegg Study Order Confirmation Chegg.com 5. Environmental standards versus tradable permits Aa Aa the government wants to reduce the total pollution emitted by three firms in its area. Currently, each frm is creating 4 units of pollution in the area, for a total of 12 pollution units. The government wants to reduce total pollution in the area to 6 units. In order to do so, the government can choose between the following two methods. Method 1: The government sets pollution standards. Method 2: The government allocates tradable pollution permits Compare the two methods to determine the least-cost way of achieving the desired pollution quantity. Eliminating pollution can be more difficult (and thus more costly) for some kinds of firms than for others. The following table shows the cost of eliminating each unit of pollution for each of the three firms. Cost of eliminating the first unit of pollution Cost of eliminating the second unit of pollution Cost of eliminating the third unit of pollution Cost of eliminating the fourth unit of pollution Firm X $500 $675 $1,100 $7,700 Firm Y $75 $100 $160 $800 Firm Z $60 $80 $120 720 Under method 1, the government sets pollution standards so that each firm must reduce its pollution by 2 units. Fill in the following table with the total cost to each firm of reducing its pollution by this amount. Firm X Firm Y Firm Z Total cost of eliminating 2 units of pollution Adding up the costs to the three firms, you can see that the total cost of eliminating 6 units of pollution through regulatory standards is

Explanation / Answer

Regulation:

Firm X: 500 + 675 = 1175

Firm Y: 75 + 100 = 175

Firm Z: 60 + 80 = 140

Total cost of eliminating 6 units of pollution = 1175 + 175 + 140 = 1490

Tradable Permits:

Cost of eliminating 3rd unit of pollution by Y and Z is $ 160 and $ 120, so if Firm X offers price greater than $ 160 then both firm will agree to eliminate their 3rd unit of pollution. So, prices at which Y and Z will sell their permits is:

1) $ 330

2) $ 305

At price of $ 158, only firm Z will sell the permit because its cost of eliminating 3rd unit of pollution is 120 which is less than the set price.

2 units

Total cost of eliminating 6 units = 500 + 175 + 260 = $ 935

Less costly when government distribute Tradable permits

Firm X Firm Y Firm Z Initial pollution permit allocation 2 units 2 units

2 units

Action Buy 1 permit Don't buy/sell Sell 1 permit Final pollution amount 1 unit 2 unit 3 unit Cost of pollution reduction 500 75 + 100 = 175 60 + 80 + 120 = 260

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