A regulator requires a company to reduce its emissions to a level below its (pre-regulation) profit-maximising level
Question:
A regulator requires a company to reduce its emissions to a level below its (pre-regulation)
profit-maximising level of emissions. The requirement will be implemented by the issue of a non-transferable licence. However, imperfect monitoring means that if the firm does not adhere to the regulation, the probability of this being discovered is p, which will in general be significantly less than one. If the company is discovered to have not adhered to the licence, however, it will face a financial penalty of
£x per unit emitted in excess of its allowed
(licensed) amount.
Show how the amount which it is optimal for your company to emit (i.e. the amount which will maximise your expected profits) depends on the values of p and x. Would the company’s decision be different if the penalty were a fixed fine, irrespective of the magnitude of its transgression?
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