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DESIGN AND DESCRIBE REPORT
Tatyana Shevnina
Writer’s comment: Design and Describe Report, an assignment for Victor Squitieri’s English 104A (Technical and Business Writing) class, required choosing a concept or an innovation and explaining it to a hypothetical superior with a vested interest but limited knowledge in the subject at hand. Among all of the interesting assignments in the class, I particularly enjoyed working on this one because I was able to apply the knowledge gained from my economics classes. Writing this report was also highly useful, because I am planning to work in the business world and am very likely to encounter similar assignments. Besides, economics interests me a great deal, and, as everyone knows, the best way to retain what one learned is to be able to explain it.
—Tatyana Shevnina
23 February, 2002
| To: | Richard Almo, Head of Research and Development | |
| From: | Tatyana Shevnina, Business Analyst | |
| Subject: | Cost Analysis and Recommendation Regarding Pollution Reduction Mandated by the EPA and Proposal to Settle ALBERTO’S FISH Lawsuit | |
| Distribution: | Rosa Parks, Owner Mark Thomas, Director Vincent Chang, Head of Finance |
As you requested in your memorandum of February 21, 2002, this report addresses the issues relevant to STEELKO’s pollution production. The first section of the report explains why the pollution produced by our factory is a negative production externality. The following section provides a cost analysis of the two EPA approved pollution reduction methods and concludes with a recommendation to implement one of the methods. The last section discusses a possible settlement for the ALBERTO’S FISH lawsuit.
EXTERNALITY
This section defines externality and explains why pollution produced by STEELKO is a negative production externality.
Definition
According to Michael Caputo, Professor of Economics at UC Davis, externality is “an action by either a consumer or producer that affects another consumer or producer, yet is not accounted for in the market price.”
Application
In the case of STEELKO and ALBERTO’S FISH, the pollution production is an action by our factory that negatively affects the fishery by poisoning the fish and disrupting their reproductive cycle. As a result of excessive pollution, the fishery suffered a substantial loss of revenue during the last year.
Before the complaint by ALBERTO’S FISH, the EPA did not regulate STEELKO’S pollution production. Furthermore, there was no existing market for pollution where steel factories could buy or sell the rights to pollute. Pollution production remained cost-free and, therefore, the management did not include it in the price of our factory’s steel output.
As a result, STEELKO produces pollution which, as described above, is not accounted for in the price of our factory’s steel and has a negative effect on the fishery; therefore, our factory’s pollution is a negative production externality.
MANDATE
In response to the complaint filed by the owner of ALBERTO’S FISH on February 18, 2002, the EPA issued a mandate which contains two separate solutions for pollution reduction. This section examines the two solutions in detail. Since we need to notify the EPA by February 28, 2002, about the chosen solution, this section includes cost estimates of the two solutions and a recommendation regarding which solution to implement.
Emissions Standard Solution
According to Daniel Rubinfeld, Professor of Economics at UC Berkeley, an emissions standard is “a legal limit on how much pollutant a firm can emit.” Currently, our factory produces five tons of chemically contaminated water per ton of steel output. The EPA ruled that if STEELKO chooses to implement the emissions standard solution to reduce its pollution level, the EPA will set the limit on the amount of contaminated water that STEELKO can produce at three tons per ton of steel output. If STEELKO exceeds the allowed level of pollution production, the EPA will charge STEELKO a fine in the amount of seven hundred thousand dollars.
To implement the emissions standard solution, STEELKO needs to reduce the level of contaminated water by two tons. In order to reduce the pollution, we need to install a filter on one of the water pipes that channel the water used in the steel production into the Mighty River. The filter will remove the toxic chemicals from the water, making the water safe for the fish in the river. The chemicals, once removed from the filter, can be reused in the steel production.
The following is the cost of filter installation and maintenance:
| Cost of Filter | $300,000 |
| Filter Installation | $100,000 |
| Salaries of Mechanics (2 @ $3,000/month) | $6,000 |
Emissions Fee Solution
An emissions fee is a monetary charge per unit of pollution produced by a firm. Since with an emissions fee pollution is no longer free, the firm has to include pollution in its production cost. As a result, the firm typically chooses to reduce the amount of output in order to minimize its cost of production.
If our factory chooses to implement an emissions fee approach to account for its excessive pollution level, the EPA will set the fee at one hundred fifty thousand dollars per ton of contaminated water. The following is the cost of an emissions fee approach:
| Amount of pollution produced (in tons) | 5 |
| Cost per ton of polluted water | $150,000 |
| Total cost: | $750,000 |
Recommendation
I recommend implementing the emissions standard solution because it is less expensive when compared to the emissions fee solution. If implemented, the emissions fee solution would significantly increase STEELKO’s production costs, leading to a decrease in the output of steel and the factory’s profits. The emissions standard solution, on the other hand, will force the factory to use the inputs effectively to reducing the pollution level and benefit the environment.
LAWSUIT
In this section, I estimate the costs of the lawsuit filed by the ALBERTO’S FISH owner and onclude with a proposal for the lawsuit settlement.
Costs
The owner of ALBERTO’S FISH, Alberto Reed, filed a lawsuit against STEELKO on February 18, 2002, for the loss of revenue incurred due to the excessive pollution produced by our factory. Mr. Reed also sued for the default on his loan payment, which occurred because of the revenue shortage and resulted in the doubling of the interest rate, as well as for subsequent emotional damages suffered as a result of stress.
The following are the estimated costs of the ALBERTO’S FISH lawsuit:
| Revenue Loss | $500,000 | ||
| Loan Payment Increase | $1,000,000 | ||
| Moral Damages | $200,000 | ||
| Total: | $1,700,000 |
| Estimated Attorneys’ Fees | $100,000 |
Since there is no guarantee that the decrease in the amount of pollution will cease to have a negative effect on the fishery, the only way to avoid future lawsuits by ALBERTO’S FISH is for Mrs. Parks to purchase the fishery. Mr. Reed will accept the settlement because he wishes to retire and the lawsuit can take anywhere up to two years, including a possible loss of the case. By purchasing the fishery, Mrs. Parks would internalize the negative production externality by including the amount of pollution produced by our steel factory into the production costs. Moreover, successful management of the steel plant and the fishery will earn Mrs. Parks support of the local government and the community.
I would like to meet with you within the next week to discuss the proposed pollution reduction method and the settlement of the ALBERTO’S FISH lawsuit.
TB/jd