(a) Unregulated, how much will each firm pollute? Why? What will total pollution be? What will each firm's profits be?
(b) The Department of Environmental Quality (DEQ) would like to reduce pollution by 60%-that is, pollution levels will be only 40% of the initial level. Initially, it proposes a requirement that each firm roll back its emissions by 60%. How much will each firm pollute? What will total pollution be? What will each firm's marginal benefits be? What will each firm's profits be?
(c) Someone in the DEQ studied environmental economics and suggests a marketable permit system to achieve the 60% rollback, with each firm given permits representing the level of its emissions in (b). Who (if either) will want to buy permits, and who will sell? How much will each firm pollute? What will be the equilibrium permit price? What will each firm's profits be?
(d) Next, someone in the DEQ suggests a pollution tax. What level of tax will achieve the desired level of pollution? How much will each firm pollute? What will each firm's profits be?
(e) A third DEQ employee suggests subsidizing the pollution reduction from the initial levels identified in (a). What level of subsidy will achieve the desired level of pollution? How much will each firm pollute? What will each firm's profits be?
(f) Rank the four regulatory approaches (rollback, permits, tax, subsidy) from the firms' perspectives. Why do they have these rankings? Do they have the same rankings? Why or
why not?
(g) Suppose that the DEQ wants to balance (i) its need to regulate pollution, (ii) effects of its regulation on polluters, and (iii) its desire to keep its budget under control. Which regulatory approach do you expect it to select? Why?
(h) There is a theory of agency behavior that suggests that one incentive of a public agency, or a division of a firm, is the desire to maximize its budget. Suppose that the DEQ, while wanting to achieve the specified pollution level, wants to maximize its budget. Which regulatory approach do you now expect it to select? Why?
(i) Arrow is located in a remote rural area, with very low pollution levels (marginal damage = 6), while Solow is located in an urban area, with other pollution sources and many more people exposed (marginal damage = 12). What is the efficient pollution allocation in this case?