ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN: 9780190931919
Author: NEWNAN
Publisher: Oxford University Press
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Transcribed Image Text:Suppose a municipality votes to reduce the combined pollution introduced by three local companies. Presently, each firm creates 4 units of pollution in
the area, for a total of 12 pollution units. The government can reduce total pollution in the area to 6 units by choosing between the following two
methods:
Methods to Reduce Pollution
1. The government imposes pollution standards using regulation.
2. The government issues tradable pollution permits.
The costs faced by each firm are different, so it is more difficult for some firms to reduce pollution than others. The following table shows the cost
faced by each firm to eliminate each unit of pollution. Assume that the cost of eliminating all 4 units of pollution (that is, reducing pollution to zero) is
prohibitively expensive for all three firms.
Firm
Firm A
Firm B
Firm C
First Unit of Pollution
(Dollars)
80
550
75
Cost of Eliminating the...
Second Unit of Pollution Third Unit of Pollution
(Dollars)
210
1,075
130
(Dollars)
130
700
90
Next, suppose that two government officials proposed alternative plans that would reduce pollution by 6 units.
Transcribed Image Text:Method 2: Tradable Permits
Meanwhile, the other employee proposes using a different strategy to achieve the government's goal of reducing pollution in the area from 12 units to
6 units. This employee suggests that the government issue two pollution permits to each firm. For each permit a firm has in its possession, it can emit
1 unit of pollution. Firms are free to trade pollution permits with one another (that is, buy and sell them) as long as both firms can agree on a price.
For example, if firm A agrees to sell a permit to firm B at an agreed-upon price, then firm B would end up with three permits and would need to
reduce its pollution by only 1 unit while firm A would end up with only one permit and would have to reduce its pollution by 3 units. Assume the
negotiation and exchange of permits are costless.
Because firm B has high pollution-reduction costs, it thinks it might be better off buying a permit from firm C and a permit from firm A so that it
doesn't have to reduce its own pollution emissions. At which of the following prices are both firm C and firm A willing to sell one of their permits to
firm B? Check all that apply.
$124
$166
O $200
$364
O $475
Firm
Firm A
Firm B
Firm C
Suppose the the government has set the trading price of a permit at $147 per permit.
Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it
costs each firm to reduce pollution to the necessary level. If a firm is willing to buy two permits, assume that it buys one permit from each of the
other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.)
Initial Pollution Permit
Allocation
(Units of pollution)
2
2
2
Action
Final Amount of Pollution
Eliminated
(Units of pollution)
Cost of Pollution
Reduction
(Dollars)
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