Question

Suppose that a government agency is trying to decide between two pollution reduction policy options. Under the permit option, 100 pollution permits would be sold, each allowing emission of one unit of pollution. Firms would be forced to shut down if they produced any units of pollution for which they did not hold a permit. Under the pollution tax option, firms would be taxed $250 for each unit of pollution emitted. The regulated firms all currently pollute and face varying costs of pollution reduction, though all face increasing marginal costs of pollution reduction. Suppose the permit policy is adopted. A firm will wish to purchase its first permit if the price of that permit is less than or equal to:

Answer 1

A firm will wish to purchase its first permit if the price of that permit is less than or equal to:

$250.

Step-by-step explanation:

a) Data and Calculations:

Pollution tax = $250

Number of pollution permits to be sold = 100

Total pollution tax = $25,000 ($250 * 100)

b) The implication is that no firm would be prepared to pay per pollution permit more than the pollution tax. Instead, firms that would buy the 100 pollution permits would like to pay less than or equal to $250. The $250 is the price level that does not make any difference to their decision. However, the price option would become more attractive if it is less than $250 per permit.