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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. Cost of Eliminating the... First Unit of Pollution Second Unit of Pollution Third Unit of Pollution Firm (Dollars (Dollars) (Dollars) Firm X 100 150 Firm Y 450 800 1,050 Firm Z 95 120 200 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. Total Cost of Eliminating Two Units of Pollution Firm (Dollars) Firm X Firm V Firm ZMethod 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 i 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 and 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 Y has high pollution-reduction costs, It thinks it might be better off buying a permit from firm X and a permit from firm Z so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm X and firm Z willing to sell one of their permits to firm Y? Check all that apply. O $102 O $164 0 $179 0 $410 0 $708 Suppose the government has set the trading price of a permit at $182 per permit. Complete the following cable with the action each firm will cake 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 Final Amount of Cost of Pollution Permit Allocation Pollution Eliminated Reduction Firm (Units of pollution) Action (Units of pollution) (Dollars) Firm X Firm Y Firm Z Regulation Versus Tradable Permits Determine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this cable.) Total Cost of Eliminating Six Units of Pollution Proposed Method (Dollars) Regulation Tradable Permits In this case. you can conclude that eliminating pollution is _ costly to society when the government regulates each firm to eliminate a certain amount of pollution than when it allocates pollution permits that can be bought and sold.Initial Pollution Final Amount of Permit Allocation Pollution Eliminated Units of pollution) Action (Units of pollution) NNN Buy one permit Buy two permits Versus Tradable Perm Don't buy/sell Sell one permit Sell two permits e total cost of eliminating six units or powation using both methods, and e ation from previous tasks to complete this table.)Initial Pollution Final Amount of Permit Allocation Pollution Eliminated (Units of pollution) Action (Units of pollution) NIN 2 Buy one permit Versus Tradable Perm Buy two permits Don't buy/sell Sell one permit the total cost of eliminating Sell two permits tion using both methods, and mation from previous tasks to compreve this table.)it Allocation Pollution Eliminat of pollution) Action (Units of pollution NNN Is Tradable Perm Buy one permit Buy two permits Don't buy/sell Sell one permit I cost of eliminatin jon using both methods, an from previous task Sell two permits table.) Total Cost of Eliminating Six Units of Pollution(Dollars) less more ting pollution is costly to society when the governmer locates pollution permits that can be bought and sold