1. (a)Suppose that two firmsAandBemit a certain pollutant. The marginal cost of reducing pollution isMCA=50+3eAfor firmAandMCB=20+6eBfor firmB, whereeAandeBare the quantities of emissions (in tons) reduced by firmsAandB, respectively. Assume that in the absence of government intervention, each firm generates 40 units of emissions. Suppose that the regulator introduces a tradable permit system and issues 30 permits, each of which allows the emission of one ton of pollution, and each firm receives 15 permits. How many, if any, permits are traded between the firms? By how many tons does each firm end up reducing its pollution? What is the minimum amount the firm selling the permits requires to sell the permits? What is the maximum amount the firm purchasing the permits is willing to pay for the permits? What is the gain in efficiency from allowing the firms to trade permits? Provide a graphical representation. (5 points)
2. (b)When there is uncertainty about the position of the marginal cost curve, an emissions fee and a cap-and-trade program can lead to different outcomes. Show (i) a case in which an emissions fee is superior to a cap-and-trade program and (ii) a case in which a cap-and- trade program is superior to an emissions fee. In both cases (i) and (ii) provide a graphical representation and an intuitive explanation. (5 points)