Answer to Question #258600 in Microeconomics for chetna

Question

Suppose that the government decides to issue tradable

permits for a certain form of pollution.

a. Does it matter for economic efficiency whether the

government distributes or auctions the permits?

Does it matter in any other ways?

b. If the government chooses to distribute the permits,

does the allocation of permits among firms matter

for efficiency? Does it matter in any other ways?

Answer 1

Pollution is a negative externity as people who emit pollution do not take into account full social cost while emitting the pollution. Efficient level of pollution is attained when marginal social cost equals marginal benefit. It is noted that in an economy that is market based, there is excessive emission of pollution as compared to the efficient level.

Pollution permits are a combination of command and control and market bases approaches to the task of limiting pollution emissions.

These permits force the firms or individuals to emit the pollution within the permit range.

It doesn't matter for economic efficiency whether the government redistributes or auctions the permits because if the government sets the permit according to the efficient level,then the level of pollution emitted must be the same in both cases and is equal to the efficient level. The permits are set in the market by different forces. When firms get higher costs of pollution reduction, the willingness to pay increases.