Question

Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has decided to reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the river. It costs Firm A $100 for each ton of pollution that it eliminates before it reaches the river, and it costs Firm B $50 for each ton of pollution that it eliminates before it reaches the river. The government gives each firm 20 pollution permits. Government officials are not sure whether to allow the firms to buy or sell the pollution permits to each other.

1. a) What is the total cost of reducing pollution if firms are not allowed to buy and sell pollution permits from each other?

1. b) What is the total cost of reducing pollution if the firms are allowed to buy and sell permits from each other?

Maggie Miller is the town manager of Medfield, a town with 50,000 residents. At a recent town meeting, several citizens proposed building a large public recreation center in the center of town for all of the residents to enjoy. A survey of all 50,000 residents revealed that the recreation center would be worth $50 to each of them, or $2,500,000 total. The cost to build the recreation center is $1,000,000. Because the benefits to building the recreation center outweigh the costs, Manager Maggie arranges to have the recreation center built.

2. a) Of the four main types of good described in class, which type is this for the citizens of Medfield, and why? (2 points)

2. b) Everyone in town enjoys using the recreation center but when Manager Miller asks for donations to pay for the center, he only collects $250,000, which is considerably less than the $2,500,000 value resident indicated previously. Using economics concepts discussed in class, explain briefly why these voluntary donations are so low.

Answer 1

PART-1)

a) Solution: $4,500

Explanation:

When firms are disallowed to buy and sell permits from each other

Firm A will be required to buy 40 permits (cost > price of permit), thus will decrease 10 tons (=50-10). Thus cost of permit will be 40*$50 = 2000

Firm B will not require permits (cost < price of permit), thus will required to decrease 50 tons. Thus cost of permit will be 50*$50 = $2,500

Thus the total cost: 2000 + 2500 = $4,500

　

b) Solution: $3,500

Explanation:

When firms are allowed to buy and sell permits from each other

Cost of reducing pollution = 10 * $100 = $1000

Total cost - Cost of reducing pollution

$4,500 - $1,000

$3,500