Suppose 3 firms with differing cost structures are emitting pollution in the amo

Question

Suppose 3 firms with differing cost structures are emitting pollution in the amounts shown below. (The cost/unit is the cost each firm faces to eliminate a unit of pollution.)

Firm   units emitted cost/unit to reduce

A 15                                $1

B 30                                $2

C 45                                $3

Assume policy makers seek to cut pollution in half (from 90 to 45 units of pollution) and are trying to choose among several alternative courses of action:

The ‘dirtiest’ producer cleans first: Firm C cleans 45 units.

Each firm cuts its own pollution in half, thus reducing overall pollution to 45 units.

Each firm reduces pollution by 15 units, thus achieving the 45 unit reduction.

45 tradeable pollution permits are created and auctioned on the open market. Without a permit, firms cannot emit a unit of pollution.

Questions:

1.Which of these alternatives is the fairest? Explain why you think so.

2. Which is the most efficient (lowest cost) alternative? Demonstrate why.

3. If efficiency is desirable, why must the permits be tradable?

Explanation / Answer

The ‘dirtiest’ producer cleans first: Firm C cleans 45 units.

In this case the cost of reducing pollution will be highest. Therefore, this option is not recommended. Total cost of reducing pollution = (45*3 = 135)

Each firm cuts its own pollution in half, thus reducing overall pollution to 45 units.

This will lead to a total cost of reducing production = (7.5*1) +(15*2) + (22.5*3) = 7.5+30+67.5 = $105

Each firm reduces pollution by 15 units, thus achieving the 45 unit reduction.

In this case, firm A produces same pollution as it was doing earlier. Firm B will reduce pollution emmission by 15 units and firm C will reduce pollution emission by 30 units

total cost = (15*2) +(15*3) = $75

45 tradeable pollution permits are created and auctioned on the open market. Without a permit, firms cannot emit a unit of pollution.

If these are auctioned highest by firm C because their cost of reducing pollution is highest, other two firms will reduce their pollution. cost will be (15*1) +(30*2) = $ 75

hence, last solution is most economic but only if all permits are purchased by firm 3 about which government cannot be sure. Therefore, best option is that each firm reduces pollution by 15 units as it will minimize the costof reducing pollution.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.