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ECON 377 Chapter Notes - Chapter 4: Contract Curve, Barter, Pareto Efficiency

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School
University of Calgary
Department
Economics
Course
ECON 377
Professor
Peter Tracey

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Document Summary

By pursuing this goal in a non-cost-effective way would be considered inefficient. *on a utility curve, any movement towards the upper right results in a pareto improvement, making the outcome more efficient. Pareto frontier: the pareto frontier consists of all allocations that are pareto preferred, and which there can be no improvement from a pareto perspective. An allocation is pareto efficient if it lies on the frontier, and is inefficient if within. We cannot say that different points on the pareto frontier are more or less socially desirable than one another, as they all have the same utility. If polluters are being regulated in such a way that their marginal costs of pollution control varies widely, then there is an opportunity for pareto improvement. A solution may be that firms with high control costs pay firms with low control costs to undertake more responsibility for pollution reduction.

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Related Questions

The P river has two polluting firms on it's banks. Acme industrialand creative chemicals each dump 100 tons of glop into the rivereach year. The cost of reducing glop emissions per ton equals $10for acne and $100 for creative. The local government wants toreduce overall pollution from 200 tons to 50 tons.

a) if the government knows the cost of reduction for each firm,what reductions will it impose to reach it's overall goal? Whatwill be the cost to each firm and total cost to the firmstogether?

b) in a more typical situation, the government does not know thecost of pollution reduction for each firm. If the governmentdecides to reach it's overall goal by imposing uniform reduction onthe firms , calculate the reduction made by each firm, cost of eachfirm and total cost of firms together.

c) compare the total cost of pollution reduction in parts a) andb). If the government does not know the cost of reduction for eachfirm is there still some way for it to reduce pollution to 50 tonsat the total cost you calculated in part a) ? Explain.

Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods:

  Available Methods to Reduce Pollution
1. The government sets pollution standards using the regulation.
2. The government allocates tradable pollution permits.

Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces to eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive.

Firm

Cost of Eliminating the...
First Unit of Pollution Second Unit of Pollution Third Unit of Pollution
(Dollars) (Dollars) (Dollars)
Firm X 80 100 150
Firm Y 450 800 1,050
Firm Z 95 120 200

Now, imagine that two government employees proposed alternative plans for reducing pollution by 6 units.

Method 1: Regulation

The first government employee suggests limiting pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units.

Complete the following table with the total cost to each firm of reducing its pollution by 2 units.

Firm Total Cost of Eliminating Two Units of Pollution
(Dollars)
Firm X ?
Firm Y ?
Firm Z ?

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 X agrees to sell a permit to firm Y at an agreed-upon price, then firm Y would end up with three permits and would need to reduce its pollution by only 1 unit while firm X 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.

Because firm Y has high pollution-reduction costs, it thinks it might be better off buying a permit from firm X and a permit from firm Z so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm X and firm Z willing to sell one of their permits to firm Y? Check all that apply.

$102

$164

$179

$410

$708

Suppose the government has set the trading price of a permit at $182 per permit.

Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it costs each firm to reduce pollution to the necessary level. If a firm is willing to buy two permits, assume that it buys one permit from each of the other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.)

Firm Initial Pollution Permit Allocation Action Final Amount of Pollution Eliminated Cost of Pollution Reduction
(Units of pollution) (Units of pollution) (Dollars)
Firm X 2 ? ? ?
Firm Y 2 ? ? ?
Firm Z 2 ? ? ?

Regulation Versus Tradable Permits

Determine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this table.)

Proposed Method Total Cost of Eliminating Six Units of Pollution
(Dollars)
Regulation ?
Tradable Permits ?

In this case, you can conclude that eliminating pollution is more/less costly to society when the government distributes tradable permits than when it regulates each firm to eliminate a certain amount of pollution.

7. Correcting for negative externalities - Regulation versus tradable permits Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods: Available Methods to Reduce Pollution 1. The government sets pollution standards using regulation. 2. The government allocates tradable pollution permits. Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces to eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive. Firm Cost of Eliminating the . . . First Unit of Pollution Second Unit of Pollution Third Unit of Pollution (Dollars) (Dollars) (Dollars) Firm X 80 130 210 Firm Y 550 700 1,075 Firm Z 75 90 130 Now, imagine that two government employees propose alternative plans for reducing pollution by 6 units. Method 1: Regulation The first government employee suggests to limit pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units. Complete the following table with the total cost to each firm of reducing its pollution by 2 units. Firm Total Cost of Eliminating Two Units of Pollution (Dollars) Firm X Firm Y Firm Z 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. He 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 X agrees to sell a permit to firm Y at an agreed-upon price, then firm Y would end up with three permits and would need to reduce its pollution by only 1 unit, while firm X 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. Because firm Y has high pollution-reduction costs, it thinks it might be better off buying a permit from firm Z and a permit from firm X, so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm Z and firm X willing to sell one of their permits to firm Y ? Check all that apply. $124 $166 $200 $364 $475 Suppose the owners of the three firms get together and agree on a trading price of $147 per permit. Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it costs each firm to reduce pollution to the necessary level. If a firm purchases two permits, assume that it buys one permit from each of the other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.) Firm Initial Pollution Permit Allocation Action Final Amount of Pollution Eliminated Cost of Pollution Reduction (Units of pollution) (Units of pollution) (Dollars) Firm X 2 Firm Y 2 Firm Z 2 Regulation Versus Tradable Permits Determine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this table.) Proposed Method Total Cost of Eliminating Six Units of Pollution (Dollars) Regulation Tradable Permits In this case, you can conclude that eliminating pollution is costly to society when the government regulates each firm to eliminate a certain amount of pollution than when it allocates pollution permits that can be bought and sold.