Reference no: EM133271362

Two firms can control pollution with the following marginal abatement costs MAC1 = 36e1 and MAC2 = 12e2, where e1 and e2 are the amount of emission reduction by firms 1 and 2 respectively. Assume that with no control at all, firm 1 would release 15 units of pollution and firm 2 would release 10 units for a total of 25 units of pollution for both firms. Suppose that the government sets a goal of reducing total pollution by 12 units resulting in a total of 13 (25-12) units of pollution.

1. The command and control approach to achieving the environmental goal of a 12 unit reduction in total pollution would be to mandate that each firm reduce emissions by 6 units. Find the total abatement costs for each firm under this command-and-control approach.

2. Suppose instead the government now institutes a cap-and-trade policy where firm 1 initially receives all of the permits. The government gives these permits to firm 1 without charge. Solve for the number of permits each firm holds and for the equilibrium price of a permit. You can assume that the permit market is perfectly competitive. Show all your workings.