What will the price of a pollution permit be in equilibrium

Reference no: EM133429112

Question: Consider a situation where there are two polluters. The government decides to set up a cap and trade system to regulate pollution. The government would like to allow 100 units of pollution in total, and gives each firm 50 permits for free (one permit is for one unit of pollution). The two firms have different marginal savings functions with respect to emissions (e).

Firm 1: MS1 = 220 - e1. Firm 2: MS2 = 300 - 2e2. Given the number of permits, the following equation must also hold: e1 + e2 = 100.

a) Given the marginal savings functions outlined in this question, recreate the figure on Slide 15 of Lecture 12. The figure should have Firm 1 on the left y-axis and Firm 2 on the right y-axis. The y-axis represents dollar amounts. The x-axis is emissions (in units of pollution).

b) Trading will occur until an equilibrium is reached. What will e1* and e2* be in equilibrium?

c) What will the price of a pollution permit be in equilibrium?

d) If the government decided they wanted to achieve the same outcome using an emissions fee, what should they set the price of one unit of pollution to be?

Reference no: EM133429112

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