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 produced.The regulated firms all currently pollute and face varying costs of pollution reduction,though all face increasing marginal costs of pollution reduction.
Because firms face increasing marginal costs to reduce pollution,demand for pollution permits will be

Question

Quizplus · Accepted Answer

Since firms face increasing marginal costs of pollution reduction, the demand for pollution permits will be downward sloping.

In terms of policy options, the pollution tax option would be more effective. This is because the tax would incentivize firms to reduce their pollution levels in the most cost-effective way possible. Firms would have an incentive to reduce pollution levels so as to avoid paying the higher tax rate. Additionally, since the tax is indexed to the level of pollution, the government can ensure that the total pollution levels fall to the desired level.

On the other hand, the permit option may not be effective in reducing overall pollution levels since firms that cannot afford to buy enough permits may shut down, leading to a reduction in production and employment levels. Moreover, the permit price may not reflect the true cost of pollution reduction, leading to market inefficiencies. Hence, the pollution tax option would be a better choice for the government agency.

Suppose That a Government Agency Is Trying to Decide Between