Since dry cleaning produces air pollution, a small town with two dry cleaning companies has decided to regulate the dry cleaning industry. The two dry cleaning companies, Company A and Company B, currently produce 350 units of air pollution, which the town wants to reduce
to 200 units. The accompanying table shows the current pollution level produced by each
company and each company's marginal cost of reducing its pollution. The firms' production marginal cost is constant.
Companies Initial pollution level Marginal cost of reduction pollution
(kgs per year) ($ per kg)
A 220 $6
B 120 $3
a) Suppose that the town were to pass an environmental standards law that limits each
company to 100 kgs of pollution. What would be the total cost to the two companies
of each reducing its pollution emissions to 100 units?
Suppose instead that the town issues 100 pollution vouchers to each company, each entitling the company to one unit of pollution, and that these vouchers can be traded.
b) How much is each pollution voucher worth to Company A on the margin (that is,
what is it willing to pay for one more voucher)? To Company B?
c) Who will sell vouchers and who will buy them? How many vouchers will be traded?
d) What is the total cost to the two companies of the pollution controls under this
voucher system?
e) Explain in one or two sentences to a non-economist why regulation is often a more
expensive way to deal with an environmental problem than market-based instruments such as permits or taxes.
a) To find the total cost to the two companies of each reducing its pollution emissions to 100 units, we need to calculate the cost for each company individually and then add them together.
For Company A:
Initial pollution level = 220 kgs
Target pollution level = 100 kgs
Pollution reduction = 220 kgs - 100 kgs = 120 kgs
Cost for Company A = Pollution reduction * Marginal cost of reducing pollution = 120 kgs * $6 = $720
For Company B:
Initial pollution level = 120 kgs
Target pollution level = 100 kgs
Pollution reduction = 120 kgs - 100 kgs = 20 kgs
Cost for Company B = Pollution reduction * Marginal cost of reducing pollution = 20 kgs * $3 = $60
Total cost to the two companies = Cost for Company A + Cost for Company B = $720 + $60 = $780
b) To determine the value of each pollution voucher to Company A and Company B, we need to calculate the marginal cost of reducing pollution for each company.
For Company A:
Marginal cost of reducing pollution = $6
For Company B:
Marginal cost of reducing pollution = $3
Therefore, the value of each pollution voucher to Company A is $6 and to Company B is $3.
c) In a voucher system, a company with a lower marginal cost of reducing pollution will be willing to sell vouchers, while a company with a higher marginal cost will be willing to buy vouchers.
In this case, Company B has a lower marginal cost ($3) compared to Company A ($6), so Company B will sell vouchers, and Company A will buy vouchers. The number of vouchers traded will depend on their respective pollution reduction targets and the quantity of vouchers each company holds.
d) To find the total cost to the two companies of the pollution controls under the voucher system, we need to calculate the cost for each company individually and then add them together.
For Company A:
Number of vouchers needed = Initial pollution level - Target pollution level = 220 kgs - 100 kgs = 120 kgs
Cost for Company A = Number of vouchers needed * Value of each voucher = 120 kgs * $3 = $360
For Company B:
Number of vouchers needed = Initial pollution level - Target pollution level = 120 kgs - 100 kgs = 20 kgs
Cost for Company B = Number of vouchers needed * Value of each voucher = 20 kgs * $3 = $60
Total cost to the two companies = Cost for Company A + Cost for Company B = $360 + $60 = $420
e) Regulation is often more expensive than market-based instruments like permits or taxes because regulation sets a specific standard or limit on pollution reduction, which may not be efficient for all firms. Market-based instruments allow firms with low pollution reduction costs to make further reductions and sell permits to firms with high pollution reduction costs, finding the lowest-cost solutions overall. This flexibility and market-driven approach can lead to more cost-effective environmental outcomes.