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Suppose there are two polluting factories, surrounded by identical residential neighborhoods. The marginal damage curves are identical for the two neighborhoods, and they are given by MD1 = P and MD2 = P, where P is the level of pollution. The marginal benefit curves for the factories, however, are different. The marginal benefit curve for the first factory is MB1 = 8 – P, while the curve for the second factory, which uses a cleaner production process, is given by MB2 = 4 – P (both curves become zero once they hit the horizontal axis).
(a) Illustrate the curves for the two neighborhoods in two diagrams, and identify the pollution levels chosen by the firms in the absence of government intervention. Find the level of social surplus achieved in this case.
(b) Find the socially optimal pollution levels in the two neighbor- hoods. Why do they differ? Compute social welfare in each neighbor- hood, and sum the values across the two neighborhoods to get total surplus. This is the surplus level that would result from imposition of separate pollution standards in the two neighborhoods.
(c) Suppose the government institutes a common pollution standard, which applies to both neighborhoods. This standard restricts pollution from any factory to a maximum value of three units. Under this stan- dard, how much does each factory pollute? Compute the resulting level of social surplus in each neighborhood, and add the values.
(d) Considering the social surplus from (a), (b), and (c), comment on the wisdom of using a common pollution standard. How does the standard compare with separate pollution standards, and with the case in which the government doesn’t intervene at all?
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