.

An industry has 3 types of firms. Small firms use a lot of labor to produce their product,

medium firms use some labor and some capital, and large firms use a lot of capital to

produce the same product. The cost of reducing pollution is based on the amount of

capital used in the production process: it costs small firms $10,000/year to comply with

pollution regulations, it cost medium firms $25,000/year to comply, and it costs large

firms $50,000/year to comply.

a.

If the cost to society of one firm violating pollution regulations is $40,000/year

which firms should comply with the regulations?

b.

If the regulator has to set a single fine for all firms in this industry and can only

catch of all firms that violate the regulations, how high should the fine be for

firms that it catches violating the regulations?

c.

Why might the regulator want to fine small, medium, and large firms different

amounts when it catches them violating the regulations? Explain how regulators

might do this in practice