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University of Notre Dame *

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310

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Economics

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Feb 20, 2024

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pdf

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6/18/22, 3:40 PM Aplia: Student Question https://ng.cengage.com/static/nb/ui/evo/index.html?deploymentId=594370205413401683037472468&eISBN=9781337096577&id=1507053616&snap… 1/4 Points: 1 / 1 Close Explanation Back to Assignment Attempts 2.4 Keep the Highest 2.4 / 5 5. Correcting for negative externalities - Regulation versus tradable permits 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. Firm Cost of Eliminating the... First Unit of Pollution Second Unit of Pollution Third Unit of Pollution (Dollars) (Dollars) (Dollars) Firm X 90 125 180 Firm Y 55 70 110 Firm Z 650 800 1,500 Now, imagine that two government employees proposed alternative plans for reducing pollution by 6 units. Method 1: Regulation The first government employee suggests limiting pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units. Complete the following table with the total cost to each firm of reducing its pollution by 2 units. Firm Total Cost of Eliminating Two Units of Pollution (Dollars) Firm X Firm Y Firm Z Explanation: In order to compute the total cost of eliminating two units of pollution for each firm, add the cost of eliminating the first unit and the cost of eliminating the second unit for each firm. The following table summarizes these calculations: 215 125 1,450
6/18/22, 3:40 PM Aplia: Student Question https://ng.cengage.com/static/nb/ui/evo/index.html?deploymentId=594370205413401683037472468&eISBN=9781337096577&id=1507053616&snap… 2/4 Points: 0.2 / 1 Close Explanation Firm Cost of Eliminating the... Total Cost of Eliminating Two Units of Pollution First Unit of Pollution Second Unit of Pollution (Dollars) (Dollars) (Dollars) Firm X 90 125 215 Firm Y 55 70 125 Firm Z 650 800 1,450 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 X agrees to sell a permit to firm Y at an agreed-upon price, then firm Y would end up with three permits and would need to reduce its pollution by only 1 unit while firm X 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 Z has high pollution-reduction costs, it thinks it might be better off buying a permit from firm Y and a permit from firm X so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm Y and firm X willing to sell one of their permits to firm Z? Check all that apply. Explanation: In order for a firm to be willing to sell one of its permits, the price it receives for the permit must exceed the cost of eliminating the unit of pollution the permit represents: Each firm can use its initial allocation of two permits to avoid eliminating the third and fourth units of pollution, which are the most costly units to eliminate. This leaves each firm, before buying or selling permits, with just having to eliminate the first two least costly units of pollution. If a firm wants to sell one of its permits, it will then have to eliminate three units of pollution. Given that the cost of eliminating the third unit of pollution is $110 for firm Y and $180 for firm X, both firms will be willing to sell one of their permits at any price above $180. Suppose the the government has set the trading price of a permit at $498 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.) Firm Initial Pollution Permit Allocation Action Final Amount of Pollution Eliminated Cost of Pollution Reduction (Units of pollution) (Units of pollution) (Dollars) Firm X 2 Sell one permit $109 $149 $170 $579 $787 2 340 3 395
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