Discuss two proposals to correct the negative externality

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Reference no: EM133253735

Assignment:

Market inefficiencies: Externalities

Scenic Lake is a beautiful tourist attraction in country Victoria. Unfortunately, two nearby canned food manufacturing firms, Firm X and Firm Y, pollute the lake. Each firm discharges 1,000 litres of polluted water to the lake every day

As a result of the lake losing its beauty, and the loss of fishing opportunities, the local tourist industry has suffered. Therefore, the State government is keen to restore the lake to its former beauty. It costs $10 per litre for Firm X, and $2 per litre for Firm Y, to clean up the water.

The State government is considering the following two proposals to correct the negative externality.

Proposal a- Impose a legal limit of 500 litres per day of waste water for each firm.

Proposal b - Assign each firm a tradable permit that allows 500 litres per day of waste water to be discharged to the lake.

a) Identify and explain the type of solution behind each of the proposals, and how each solution will correct the externality.

b) Assume that the State government adopts proposal b. and issues tradeable permits allowing each firm to pollute up to 500 litres per day. Explain how the market will work to internalise the externality.

Hint: You must explain in your answer how and why the trade will happen.

Reference no: EM133253735

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