Suppose the local authorities wanted to achieve a more drastic reduction in total pollu- tion of 75 tons in the scenario described above. They want to do so via the introduction of a tradable pollution permits system whereby, each permit would allow a power plant to emit one ton of SO2 annually at no cost, but a power plant’s emissions may not exceed it’s permits. The authorities must will distribute 75 permits (to achieve the 150 - 75 = 75 ton reduction). Recall that prior to the policy, each plant is emitting 75 tons. '(a) If the regulator issues 35 permits to firm 1 and 40 permits to firm 2, without trading, how much would each firm have to spend to comply with the regulation? Recall that each firm must abate the pollution for which they do not hold permits. i.e. q1 = 75 −p1 where p1 is the number of permits firm 1 has. (b) At this initial allocation, what is the marginal willingness to pay a permit for firm 1? What is the marginal willingness to accept to sell a permit for firm 2
Suppose the local authorities wanted to achieve a more drastic reduction in total pollu-
tion of 75 tons in the scenario described above. They want to do so via the introduction
of a tradable pollution permits system whereby, each permit would allow a power plant
to emit one ton of SO2 annually at no cost, but a power plant’s emissions may not exceed
it’s permits. The authorities must will distribute 75 permits (to achieve the 150 - 75 =
75 ton reduction). Recall that prior to the policy, each plant is emitting 75 tons.
'(a) If the regulator issues 35 permits to firm 1 and 40 permits to firm 2, without trading,
how much would each firm have to spend to comply with the regulation? Recall
that each firm must abate the pollution for which they do not hold permits. i.e.
q1 = 75 −p1 where p1 is the number of permits firm 1 has.
(b) At this initial allocation, what is the marginal willingness to pay a permit for firm
1? What is the marginal willingness to accept to sell a permit for firm 2? Should
they trade?
(c) Find the efficient allocation of permits. How much must each firm spend on pollu-
tion control under the efficient permit allocation?
(d) Assume firms traded from the initial allocation (35, 40) to the efficient allocation
found above. Solve for the permit price, the total amount paid by firm 1 (and thus
received by firm 2). Can you show that trading made both firms better off than
they would have been under the initial allocation if permits were not tradable?
HINT: Compare the total costs in part (a) to the costs of abatement under the effi-
cient allocation plus the costs/revenues from permit sales.
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