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There are two firms with the following MB of emissions curves:
MB1(E) = 16 − 2E
MB2 (E) = 8 − E
The regulator sets up a permit trading system. Suppose the initial allocation of permits is free, and set equal to 50% of each firm’s no-regulation emissions level.
(a) Find the equilibrium permit price. Hint: The two conditions for a permit price equilibrium will allow you to solve for the emissions levels for each firm after trading.
(b) What is the total cost-savings from trading?
(c) Suppose the SMC(E) = 5. Would the permit price be set too high or too low? Is the resulting allocation efficient? Is it cost-effective? What can the regulator do to reduce DWL?(a) In the real world, why might it be difficult for regulators to come up with the efficient set of standards corresponding to different firms? How do tradable permits help regulators in this situation?
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