Question

Suppose that a new chief of the government agency discussed in the problem decides to reduce the number of pollution allowances that firms are permitted to own. Evaluate the effects this policy change will have on the market price of pollution allowances and discuss whether the policy appears to be fully consistent with the original intent of creating the market for these allowances.

Short answer

This policy will affect the price of allowances in the market, which will have an ultimate effect on the production of the overall level of pollution.

Step-by-step solution

Determine whether the competitive market is an efficient market.

The efficient market is the ultimate competitive market. Government intervention in the market leads to inefficiency. However, there are some things for which no market exists, necessitating government intervention.

Determine which government agency'sto restrict the size

The head of the government agency chooses to limit the size of the firm's use of pollution allowances. This policy will alter the market price of permits, which will have an impact on the total amount of pollution output.

Determine the policy

The policy adjustment will have a favorable impact on allowance prices, and demand for allowances will reduce as prices increase.The market price will grow, while the equilibrium demand for permits will shrink. As a result, the policy achieves the goal for which it was designed.