Imagine the government wants to reduce the total pollution emitted by three large firms in its area. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. The government wants to reduce total pollution in the area by a quarter - that is, reduce it to 9 units. In order to do so, the government can choose between two methods:

• Method 1: The government sets pollution standards via direct regulation.
• Method 2: The government sets a corrective tax that results in the same level of pollution reduction.

This problem compares the two methods and determines the least-cost way of achieving the desired pollution quantity.

Eliminating pollution can be more difficult, and thus more costly, for some kinds of firms than for others. The following table shows the cost of eliminating each unit of pollution for each of the three firms.

Firm X

Firm Y

Firm Z

Cost of eliminating the first unit of pollution

$50

$125

$100

Cost of eliminating the second unit of pollution

$90

$200

$135

Cost of eliminating the third unit of pollution

$140

$275

$190

Assume that the cost of reducing pollution to zero (in other words, eliminating all four units) is prohibitively expensive.

Imagine that in order to regulate pollution, the government sets pollution standards so that each firm must reduce its pollution by 1 unit. Fill in the following table with the total cost to firms Y and Z of reducing pollution by this amount. The cost for firm X has been filled in for you as an example. (Note that you shouldn't use commas, decimals or dollar signs when entering in the values.)

Firm X

Firm Y

Firm Z

Total cost of eliminating one unit of pollution

$50

$Answer

$Answer

Adding up the costs to the three firms, you can see that the total cost of eliminating 3 units of pollution through standards of pollution is $Answer

.

Now, imagine the government decides to use a different strategy to achieve its goal of reducing pollution in the area from 12 units to 9 - namely, it sets a corrective tax.

With a corrective tax, firms have to pay a fee for every unit of pollution they emit. However, they can avoid the fee by reducing their pollution. As a result, firms have a choice for every unit they emit: eliminate it or pay the tax.

Imagine the government sets the tax at $110 per unit of pollution. Fill in the following table with firm Y's decision, assuming it wants to minimise its combined costs of pollution reduction and taxation.

Cost of Eliminating

Tax from Not Eliminating

Eliminate Pollution or Pay Tax?

First unit of pollution

$125

$110

Answer

Eliminate pollutionPay tax

Second unit of pollution

$200

$110

Answer

Eliminate pollutionPay tax

Third unit of pollution

$275

$110

Answer

Eliminate pollutionPay tax

As a result, with a corrective tax of $110 per unit, firm Y will reduce its pollution byAnswer

1230units.

Again, imagine that you are considering the method of pollution reduction involving a corrective tax. Imagine the government sets the tax at $120 per unit of pollution. Fill in the following table with the amount each firm will pollute and the amount it costs each firm to reduce pollution to that level, assuming, as before, that each firm tries to minimise its combined costs of pollution reduction and taxation. (Note: Do not include the cost of the tax in the cost of reducing the pollution. This tax is a cost for the firms but a gain to the government, so the net cost to society of the tax is zero.)

Firm X

Firm Y

Firm Z

Initial pollution level

4 units

4 units

4 units

Pollution reduction

Answer

0 units1 unit2 units3 units

Answer

0 units1 unit2 units3 units

Answer

0 units1 unit2 units3 units

Final pollution amount

Answer

0 units1 unit2 units3 units4 units

Answer

0 units1 unit2 units3 units4 units

Answer

0 units1 unit2 units3 units4 units

Cost of reducing pollution to final amount (not including tax)

$Answer

$Answer

$Answer

Given this scenario, the total cost of eliminating 3 units of pollution with a corrective tax of $120 is$Answer

.

On the basis of this example, you can conclude that eliminating pollution isAnswer

lessmoreno more or lesscostly to society when the government enacts a corrective tax than when it directs each firm to eliminate a certain amount of pollution.