Consider two firms whose marginal costs of production

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Consider two firms whose marginal costs of production are MC(Q1) = 10Q1; MC(Q2) = 5Q2: Suppose each unit of output produced, Q, results in one unit of emissions, E. Suppose the two firms sell their output in a perfectly competitive market, with perfectly elastic demand at a price of $90. Furthermore, suppose there is a constant external cost of emissions of $10.

Now suppose the regular decides to implement a cap and trade system to attain the socially optimal level of emissions via the Coase theorem. Firm 2 has more political clout, however, so the regulator distributes all permits to firm 2.

(a) How many permits should the regulator allocate to firm 2?

(b) Now suppose firm 2 sells permits to firm 1 such that they get to the socially optimal allocation of emissions across the two rms. How many permits would firm 2 sell to firm 1?

(d) What is the maximum price firm 1 would be willing to pay for these permits?

Reference no: EM13994506

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