2. Suppose the local authorities wanted to achieve a more drastic reduction in total pollution of 75 tons in the scenario described above. They want to do so via the introduction of a tradable pollution permits system whereby, each permit would allow a power plant to emit one ton of SO2 annually at no cost, but a power plant’s emissions may not exceed its permits. The authorities must distribute 75 permits (to achieve the 150 - 75 = 75-ton reduction). Recall that prior to the policy, each plant is emitting 75 tons.

   1. (a)  If the regulator issues 35 permits to firm 1 and 40 permits to firm 2, without trading, how much would each firm have to spend to comply with the regulation? Recall that each firm must abate the pollution for which they do not hold permits. i.e. q1 = 75 − p1 where p1 is the number of permits firm 1 has.

   2. (b)  At this initial allocation, what is the marginal willingness to pay a permit for firm 1? What is the marginal willingness to accept to sell a permit for firm 2? Should they trade?

   3. (c)  Find the efficient allocation of permits. How much must each firm spend on pollution control under the efficient permit allocation?

   4. (d)  Assume firms traded from the initial allocation (35, 40) to the efficient allocation found above. Solve for the permit price, the total amount paid by firm 1 (and thus received by firm 2). Can you show that trading made both firms better off than they would have been under the initial allocation if permits were not tradable?HINT: Compare the total costs in part (a) to the costs of abatement under the effi- cient allocation plus the costs/revenues from permit sales.

Answer rating: 100% (QA)

a Firm 1s emissions 75 tons Firm 2s emissions 75 tons Firm 1s cost of abating ... View the full answer