Question

The residents in the City of Irwindale are complaining about the “spicy” air from the two Sriracha factories in the city. The residents are demanding the Mayor reduce the air pollution by requiring the factories to use specialty air filters. Currently each company is polluting 6 units of spicy air, but must cut pollution in half. Each company will receive 3 pollution credits and must eliminate the remaining pollution.

Chili Corp.			Rooster Inc.
Reduced units of spicy air	Total Cost	Marginal Cost	Reduced units of spicy air	Total Cost	Marginal Cost
1	5	5	1	16	16
2	12	7	2	34	18
3	21	9	3	54	20
4	32	11	4	76	22
5	45	13	5	100	24
6	60	15	6	126	26

a. If they can buy/sell the credits, which company would prefer to buy credits and why?

b. If they can negotiate an agreement, by how many units will Chili Corp. reduce pollution and by how many will Rooster reduce pollution?

c. Explain how property rights (the right to pollute) will lead to an efficient outcome.

d. Is this a good example of a negative externality? Explain.

Answer 1

ANSWER:

A) Rooster Inc will prefer to buy credits as they have a high marginal cost in comparision to chili corp. So it will be beneficial for them to buy the credits.

B) If they can negotiate an agreement, then chili corp. They wil reduce the pollution by 6 units and sell the credits to Rooster Inc, whereas as Rooster Inc will not reduce any amount of pollution.

C) As authorities have asked to reduce pollution by half then the total amount of pollution can be 6 units. As chili corp has low abatement cost, it will reduce its emission and sell the credits to Rooster Inc.This will lead to maxmized benefits and reduced pollution.

D) Ofcourse yes, it is true, it is also a good example of a negative externality as firms induce a negative external cost on the living of the people.

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