Two plants are emitting a uniformly mixed pollutant called gunk into the beautif

Question

Two plants are emitting a uniformly mixed pollutant called gunk into the beautiful sky over Tourist-Town. The city government decides that it can tolerate total emissions of no more than 100 kgs of gunk per day. Plant G has marginal reduction costs of 80-4x, and is currently polluting at a level of 20, while plant K has marginal reduction costs of 100-y, and currently pollutes at a level of 100 (x and y are the level of emissions at each plant).

1) What is the cost-effective pollution level for each plant if total pollution must equal 100 (3 pts)?
Suppose the city government knows marginal reduction costs at the two plants. In this case could the city obtain cost-effective pollution reduction using a Command and Control (CAC) approach; if so, how (2 pts)?

2) Now assume that the city is having a hard time getting this information. So what are the two "Incentive-Based" policies that could be used to get a cost-effective reduction of pollution to 100 units, without knowing the MC of the two firms? (3 pts)  
Discuss two advantages each method has over the other (2 pts).  

3) Suppose the authorities are considering a tradable emission permit system in which they give half the permits to each firm, or a tax system. If both systems work perfectly, how much will the firms (Plant G & K) have to pay, in total, for pollution reduction under the two schemes (4+4=8 pts; note: you may draw graphs for your own calculation but you don't have to submit it)? Could this explain why Tourist-Town would be more likely to adopt a permit system over the tax system or vice versa (2 pts)?

Explanation / Answer

1) Marginal cost of Plant G for reducing pollution emission is MCG = 80-4x

Marginal cost of Plant K for reducing pollution emission is MCk = 100-y where x, y are level of pollution emission by Plant G and Plant K respectively.

If both plants has to bring down emission level to 100 then x + y = 100 .............(i)

For cost effective pollution level, marginal cost of reducing pollution emission levels of both plants must be equal

i.e., 100-y= 80-4x .................(ii)

Solving (i) & (ii) y= 84 and x= 16

If marginal reduction costs of both plant G and K are known, then cost effective pollution reduction cannot be obtained using Command and Control approach because Cost and control (CAC) regulation sets specific pollution emission limit and each firm must install effective pollution control devices to bring down pollution emission upto permissible limit. However, CAC does not provide any incentive to the firms that are able to bring down their pollution emission levels below the set limit. Another drawback of CAC approach is that it is framed by legislators who may manipulate legislations for political objective.

2) If pollution emission data and marginal reduction costs are unknown then the city government can adopt economic incentive policies to bring down the total pollution emission level in the city to 100. The economic incentives or market based policies that include offering financial incentives to private firms to bring down pollution emission level upto a set limit. The market based incentives also include motivating industries to install cost effective pollution control equipments.

Another incentive approach is the regulatory policy that sets guidelines for pollutiing units to bring down pollution emission to specific limit. The regulatory policy sets different standards for different production units based on several factos such as size and type of the unit, nature of pollution emission etc. The regulatory policy is more advantageous than market based incentive policy because it is designed such that same pollution emission standard are set for industries under one specific category. The regulatory policy also sets standard for using least expensive pollution control technology or plant design that ultimately reduces cost of production of the firm.

The same benefits of market based incentive approach has, first it reduces the firm's production costs that ultimately reach to customers in the form of cheaper products and second it induces the production units to reduce pollution emission level below the permissible limit as per the law.

3) Total pollution emission level by both plants is 120, in order to reduce pollution emission by 20 a total of 100 permits should be issued distrbuted equally to Plants G & K i.e., 50 to each plant.

Also from MCG = MCK = 16 from 1

Thus for 50 permits, Plant G has to pay 50 x $16 = $800

Similarly Plant K has to pay 50 X $16 = $800

thus the total cost that both plant has to pay is $800 X2 = $1600.

Tradable Permit system is more advantageous than the tax system for the business firms, because it allows firms to sell some of their permits to get revenue. A firm can sell its permits to another firm that has effectively controlled pollution emission in its production facility. Thus Tourist town is more likely to adopt tradable permit system rather than tax system.

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