Firm 1's unregulated level of emissions: 100 units Firm 2's unregulated level of emissions: 25 units Total unregulated level of emissions: 125 units Price of permits in a competitive trading market: $75 Firm 1 sells 5 permits, Firm 2 buys 5 permits. Explanation: In an unregulated environment, each firm will emit until their marginal abatement cost (MAC) is zero. Setting MAC equal to zero and solving for e (emissions), we find that Firm 1 emits 100 units (100-e1=0, so e1=100) and Firm 2 emits 25 units (100-4e2=0, so e2=25). The total unregulated emissions are 125 units (100+25). When the regulator issues 25 permits, Firm 1 gets 10 and Firm 2 gets 15. The firms can trade these permits. The price of the permits will be determined by the point where the MACs of the two firms are equal because that's where the cost of reducing an additional unit of pollution is the same for both firms. Setting the two MACs equal to each other and solving for e gives e1=75. Substituting e1=75 into either MAC equation gives a permit price of $75. Firm 1, with a higher MAC, will want to emit more and will therefore buy permits. Firm 2, with a lower MAC, will want to emit less and will therefore sell permits. Firm 1 will buy 5 permits from Firm 2, who will sell 5 permits. This is because the initial allocation of permits (10 to Firm 1 and 15 to Firm 2) is not the cost-effective allocation. The cost-effective allocation is for Firm 1 to have 15 permits (because it has a higher MAC and ther