In this experiment, you are all producers of a good that can be sold on the open market for $12 per unit. The good costs nothing to produce, but production results in one unit of pollution per unit produced. There will be a number of decision making periods. In each period, you have the opportunity to produce up to two units of the good. You should keep track of transactions that take place on the attached record sheet.

Part I

In this part of the experiment, you should choose your level of production (0, 1, or 2 units), and record this and your "revenue from production" ($12 * your level) in columns (1) and (2) on your record sheet. Transfer this amount to column (6) labeled "earnings." Disregard columns (3) - (5) since they are irrelevant for this part of the experiment.

Part II

Your production process causes damage to the environment, and hence has been regulated by the Environmental Protection Agency. For each unit of the good that you produce, you must either submit a pollution permit or incur a cost to abate the pollution. The cost of abatement is the number on the card that you have been given and this cost is incurred for each unit of pollution that you abate. At the beginning of period 2, we will give each of you one pollution permit. As in period one, you must decide how many units to produce. If you choose to produce one unit, you will emit one unit of pollution and must relinquish your pollution permit. If you choose to produce two units, you must relinquish your pollution permit and you must pay the cost (on your card) to abate one unit of pollution. All permits held at the end of the period have no value and must be returned. Complete columns (1), (2), (3), and (6) for this period and ignore columns (4) and (5).

Part III

In period 3, you will be regulated in the manner described above. As in period 2, you will each be given one permit and you must pay the abatement cost on your card for any units you produce without permits. At the beginning of this period, you will be given 5 minutes to buy and sell permits from each other. If you wish to buy or sell a permit, you should come to the trading area at the front of the room and announce that you will buy or sell a permit, and the price at which you are willing to make that transaction. You may negotiate with one or more firms if you so desire. At the end of the 5 minutes, you must commit to a level of production (0 units, 1 unit, or 2 units), submit any permits that you have, and pay abatement costs for any units that you produce without accompanying permits. If you hold one permit and produce two units, you incur the cost on your card to comply with the EPA regulation. If you have no permits at the end of the period and you choose to produce two units of the good, you incur two times the cost number on your card to comply with the EPA regulation. Permits cannot be carried over from period to period. Subsequent periods will be conducted in a similar manner, however, the initial distribution of permits may vary from period to period. Complete all six columns on your record sheet for this part of the experiment.