Since dry cleaning produces air pollution, a small town with two dry cleaning companies has decided to regulate the dry cleaning industry. The two dry cleaning companies, Company A and Company B, currently produce 350 units of air pollution, which the town wants to reduce

Question

to 200 units. The accompanying table shows the current pollution level produced by each
company and each company's marginal cost of reducing its pollution. The firms' production marginal cost is constant.

Companies Initial pollution level Marginal cost of reduction pollution
(kgs per year) ($ per kg)
A 220 $6
B 120 $3

a) Suppose that the town were to pass an environmental standards law that limits each
company to 100 kgs of pollution. What would be the total cost to the two companies
of each reducing its pollution emissions to 100 units?

Suppose instead that the town issues 100 pollution vouchers to each company, each entitling the company to one unit of pollution, and that these vouchers can be traded.

b) How much is each pollution voucher worth to Company A on the margin (that is,
what is it willing to pay for one more voucher)? To Company B?
c) Who will sell vouchers and who will buy them? How many vouchers will be traded?
d) What is the total cost to the two companies of the pollution controls under this
voucher system?
e) Explain in one or two sentences to a non-economist why regulation is often a more
expensive way to deal with an environmental problem than market-based instruments such as permits or taxes.