Question
5. Suppose two firms, 1 and 2, have marginal abatement cost functions given by MAC = 90-3 MAC = 50-e2 Where e; is emissions
5. Suppose two firms, 1 and 2, have marginal abatement cost functions given by MAC = 90-3 MAC = 50-e2 Where e; is emissions of a pollutant for firm i. a) Suppose the regulator requires each firm to reduce its emissions to one-half of its uncontrolled level. Explain why this is not cost effective and calculate the overall excess abatement cost of this solution compared to the cost-effective solution for achieving the same total level of abatement. (5) b) Now assume the regulator allocates pollution permits to each of the two firms equal to one- half of their uncontrolled levels of pollution (1 unit of pollution requires 1 permit) and allows them to trade permits if they wish. If there is trade, what quantity does each firm buy or sell to or from the other, and at what price, assuming they trade at the equilibrium price? (5)
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