5. Correcting for negative externalities -Regulation versus tradablepermits Supp
ID: 1144715 • Letter: 5
Question
5. Correcting for negative externalities -Regulation versus tradablepermits Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods Available Methods to Reduce Pollution 1. The government sets pollution standards using regulation 2. The government allocates tradable pollution permits Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces to eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive First Unit of Pollution (Dollars) 80 550 75 Cost of Eliminating the... Second Unit of Pollution (Dollars) 130 700 Third Unit of Pollution Firm Firm X Firm Y Firm Z (Dollars) 210 1,075 130Explanation / Answer
When regulation gets implemented and each firm has to abate 2 units equally then cost would be as follows:
But if tradeable permits get allowed then a lower abating cost firm would sell its permit at a price hwich will be more than the additional abating cost of extra unit that it had to abate when it sells off its one permit.
Hence if X sells a permit it would have to incurr $210 additionally for reducing one more level of pollution and similarly firm z if sells one permit then it will incurr additional $130 to abate third unit of pollution.
Hence firm X will agree to sell its permit if price is more than $210 and Z will sell if price of permit will be more than $130. Hence at price more than $210 both firms wil agree to sell theri permits. thus options - $364 and $475 are correct.
If price of permit is set to be $147 then only firm Z will agree to sell to its permit as only it's abating cost of 3rd unit is lesser than the price.
Total costs of reduction under both method;
Regulation = 210+1250+165=$1625
Permits = 210+550+295=$1055
It can be concluded that eliminating pollution is less costly to society when tradeable permits are distributed than when it is regulated.
Total Cost Firm X 80+130=210 Firm Y 550+700=1250 Firm Z 75+90=165 1625Related Questions
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