Problem 2 There are three industrial firms in Happy Valley F

Problem 2. There are three industrial firms in Happy Valley Firm nitial pollution level Cost of reducing pollution by 1 unit A 70 B 80 C 50 $20 $25 $10 The government wants to reduce pollution to 120 units, so it gives each firm 40 tradable pollution permits (a) Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation? (b) How much higher would the costs of pollution reduction be if the permits could not be traded?

Solution

ans.....
A.
A permit is worth $25 to firm B, $20 to firm A, and $10 to firm C, because that is the cost of reducing pollution by one unit. Because firm B faces the highest costs of reducing pollution, it will keep its own 40 permits and buy 40 permits from the other firms, so that it can still pollute 80 units. That leaves 40 permits for firms A and C. Because firm A values them most highly, it will keep its own 40 permits. So it must be that firm C sells its 40 permits to firm B. Thus firm B does not reduce its pollution at all, firm A reduces its pollution by 30 units at a cost of $20 x 30 = $600, and firm C reduces its pollution by 50 units at a cost of $10 x 50 = $500. The total cost of pollution reduction is $1,100.
B. If the permits could not be traded, then firm A would have to reduce its pollution by 30 units at a cost of $20 x 30 = $600, firm B would reduce its pollution by 40 units at a cost of $25 x 40 = $1,000, and firm C would reduce its pollution by 10 units at a cost of $10 x 10 = $100. The total cost of pollution reduction would be $1,700, $600 higher than in the case in which the permits could be traded.