Reference no: EM132422666

Question 1: There are two polluting firms in an industry. Each firm is initially generating 200 tons of pollution each year. Each faces the following costs in reducing pollution.

Cost of reducing pollution by one ton

Firm A                 $20

Firm B                  $10

The government has recently set a goal of reducing industrial pollution in the industry by 50% and is considering two policies to achieve this.  The first policy would require all firms in the industry to reduce pollution by 50%. The second policy would involve issuing 100 tradable permits to each firm. (With tradable permits, each permit would allow the firm owning it to produce one ton of pollution annually.  Firms would be free to buy and sell these permits as they desired. It would be illegal for firms to produce more pollution than the amount of pollution covered by the permits they own.)

A. If the government goes with the first option and requires each firm to cut its pollution in half, what is the annual cost of this pollution reduction strategy?

B. Instead, suppose the government decides to give each firm 100 tradable permits, as described above. How many permits will be bought and sold each year, and by whom? Explain using numerical evidence.

C. What is the total annual cost of pollution reduction under this system of tradable permits?

D. Compare the costs of pollution reduction under the two policies.  Which policy is more socially efficient?