Question: Firms A and B each produce 80 units of pollution

Firms A and B each produce 80 units of pollution. The federal government wants to reduce pollution levels. The marginal costs associated with pollution reduction are MCA = 50 + 3QA for firm A and MCB = 20 + 6QB for firm B, where QA and QB are the quantities of pollution reduced by each firm. Society’s marginal benefit from pollution reduction is given by MB = 590 – 3Qtot, where Qtot is the total reduction in pollution.
a. What is the socially optimal level of each firm’s pollution reduction?
b. How much total pollution is there in the social optimum?
c. Explain why it is inefficient to give each firm an equal number of pollution permits (if they are not allowed to trade them).
d. Explain how the social optimum can be achieved if firms are given equal numbers of pollution permits but are allowed to trade them.
e. Can the social optimum be achieved using a tax on pollution?

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