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Complete the following Exercises. Use complete sentences.
Consider two firms who each release 10 units of pollution initially, for a total of 20 units. Their supply curves for abatement are given below. These supply curves measure the marginal cost of abatement, or the cost of cleaning up each unit of pollution. For example, it costs firm 1 $40 to clean up (or abate) the 1st unit, $80 to clean up the 2nd unit, and so forth.
Supply of Abatement
UnitFirm 1Firm 2
1$ 40$ 36
A.) Assume that the damages from the pollution are an external cost from the standpoint of the two firms. How many units will each abate? Why?Why are their marginal costs of abatement (supply curves) rising as they eliminate more pollution (i.e., as they get closer to zero units of pollution)?
Now assume the Environmental Protection Agency has determined that the desired level of pollution for this industry is 10 units. That is, the pollution released from these two firms must add up to 10 units. Assume this is the EPA’s objective for the following problems.
B.) Suppose the two firms are regulated with a uniform standard. A standard specifies the maximum number of emissions units that a firm can release. A uniform standard is a standard that sets the same limit for all regulated firms. What uniform standard would the EPA use to achieve the pollution objective stated above? What is the total abatement costs associated with this uniform standard? Show your work.
C.) Suppose, instead, that the firms are regulated with a pollution tax. With a tax, firms are required to pay a specified amount for each unit of pollution that they release. What tax would the EPA use to achieve the pollution objective of 10 units? [Note: there is a range of correct answers]. What is the total abatement costs associated with this tax? Show your work. How much does each firm pay to the government in taxes (i.e., what is the total tax bill for each firm)? Show your work.
Now suppose that the firms are regulated with tradable emissions permits. Each permit allows a firm to release one unit of pollution and so the EPA issues 10 permits to achieve their pollution objective.
D.) Suppose that, initially, all 10 permits are given to firm 1. Will firm 1 sell any of their permits to firm 2? How will the permits be allocated between the two firms after all trading is completed?
E.) Now, start again but give all of the 10 permits to firm 2. Will firm 2 sell any of their permits to firm 1? How will the permits be allocated between the two firms after all trading is completed? Explain your answers.
F.) What are total abatement costs under the tradable emissions permit program? That is, how much do the firms spend on abatement at the final allocation of permits after all trading is completed? Compare your result to the total abatement costs under the uniform standard and under the pollution tax.
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