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 1. The government imposes pollution standards using regulation. 2. 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. Firm Firm A Firm B Firm C 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. Firm Firm A Firm B Firm C 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 (Dollars) 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 firm 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. $102 First Unit of Pollution (Dollars) 80 450 95 Because firm B has high pollution-reduction costs, it thinks it might be better off buying a permit from firm A and a permit from firm C so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm A and firm C willing to sell one of their permits to firm B? Check all that apply. $164 Cost of Eliminating the... Second Unit of Pollution Third Unit of Pollution (Dollars) (Dollars) 100 150 800 1,050 120 200 O $179 $410 $708