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# Solution 2: Tradeable Permits - PowerPoint PPT Presentation

Solution 2: Tradeable Permits. Suppose we gave each company 30 pounds in tradeable permits, so Firm 1 must reduce by 20 and Firm 2 by 40. Firm 1 would be willing to sell 20 pounds of permits for \$30, and those permits would be worth \$60 to Firm 2. So Firm 1 would sell them.

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• Suppose we gave each company 30 pounds in tradeable permits, so Firm 1 must reduce by 20 and Firm 2 by 40.

• Firm 1 would be willing to sell 20 pounds of permits for \$30, and those permits would be worth \$60 to Firm 2. So Firm 1 would sell them.

• If Firm 1 reduces by 20 pounds, its MC of reducing a little more is only \$1/pound.

• If Firm 2 reduces by 40 pounds, its MC of reducing a little less is \$4/pound.

• So Firm 1 could sell Firm 2 a pound of pollution permits for \$2 and both would end up better off. Firm 1 would have to pay \$1 extra for pollution control, and Firm 2 would get to pay \$4 less.

• They would keep trading more and more permits until the MC’s were equalized for the two firms.

• If Firm 1 sells 20 pounds of pollution permits to Firm 2, Firm 1’s pollution control costs go up \$30, Firm 2’s fall by \$60, and both firms would have MC=\$2. They wouldn’t trade any more because after 20, Firm 1 need them as much as Firm 2.

• If Firm 1 reduces pollution by 40 pounds and Firm 2 reduces by 20 pounds, there is a gain of \$30 in pollution control costs compared to when Firm 1 reduces by 20 and Firm 2 by 40.

• The same environmental goal of a 60-pound reduction is reached, but at lower cost.