1.There are two coal plants that generate electricity, firm 1 and firm 2 emit 160 and 160 tons of CO2each year respectively when the price of pollution is zero (i.e., in the absence of any regulation). You are the head of the EPA, and after consulting with some environmental economists, you decide that the socially optimal amount of abatement in the electricity industry is 120 tons of CO2. The marginal abatement cost curves are given by the following, where Q1and Q2are the amount of firm 1 and 2's abatement:

MAC1= (3/2)Q1

MAC2= 30 + Q2

(a) (9 points) Draw a well labeled MAC diagram, indicating the value of all vertical intercepts. In a cap and trade system, determine how much firm 1 and firm 2 abate their pollution. Determine, , the price of a 1 ton CO2pollution permit, and the # of pollution permits issued. Show your answers in the diagram you have for part (a).

(b) (6 points) Historically, new environmental regulations usually require new plants to undertake all reductions in pollution, while existing firms are not subject to the new regulation. For only this part, assume that firm 1 is the existing firm, while firm 2 is the new firm, and that all of the 120 tons of CO2reductions must come from the new firm. In your diagram from part (a), label this outcome on the horizontal axis as point C. Determine if point C is efficient, and explain your intuition.