5. Correcting for negative externalities - Regulation versus tradable permits Suppose a municipality votes to reduce the combined pollution introduced by three local companies. Presently, each rm 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 bv 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 rm are different, so it is more difcult for some rms to reduce pollution than others. The following table shows the cost faced bv each lm 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. First Unit of Pollution Cost of Eliminating the... Second Unit of Pollution Third Unit of Pollution Firm (Dollars) {Dollars} (Dollars) Firm in 95 120 200 Firm B 450 800 1,050 Firm C 30 100 150 ext. suppose that two government ofcials proposed alternative plans that would reduce pollution by 6 units. lethod 1: Regulation he rst government employee suggests reducing pollution through regulation. To meet the pollution goal. the government requires each firm to aduce its pollution by 2 units. Compfete the foifowi'ng table with the total cost to each rm of reducing its pouh'on by 2 units. Total Cost of Eliminating Two Units of Pollution Firm (Dollars) Firm A \\:| Firm B \\:| Firm C \\:| 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 rm 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 rm B has high pollution-reduction costs, it thinks it might be better off buying a permit from rm 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 is rm C willing to sell one of its permits to rm B, but firm A is not? Check ail that appiy. Because firm B has high pollution-reduction costs, it thinks it might be better off buying a permit from rm 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 is rm C willing to sell one of its permits to rm 3, but firm A is not? Check all that apply. Cl $90 [3 $1?3 [3 $186 [3 $451 [3 $529 \fetermine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need get information from previous tasks to complete this table.) Total Cost of Eliminating Six Units of Pollution Proposed Method (Dollars) Regulation less Tradable Permits more this case, you can conclude that eliminating pollution is costly to society when the government regulates each firm to eliminate a ertain amount of pollution than when it allocates pollution permits that can be bought and sold