Chapter $10$ Homework

$5.$ Correcting for negative externalities $-$ Regulation versus tradable permits

Suppose a municipality votes to reduce the combined pollution introduced by three local companies. Presently, each firm 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 by choosing between the following two methods:

Methods to Reduce Pollution

The government imposes pollution standards using regulation.

The government issues tradable pollution permits.

The costs faced by each firm are different, so it is more difficult for some firms to reduce pollution than others. The following table shows the cost faced by each firm 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.

$\backslash$table$[[,,,],[,,,],[,,,]]$

Next, suppose that two government officials proposed alternative plans that would reduce pollution by $6$ units.

Method $1$: Regulation

The first government employee suggests reducing pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by $2$ units.