Question: Suppose the world has two countries a , and b. Each generates carbon emissions. The marginal abatement cost curves for abatement are given for each

Suppose the world has two countries a, and b. Each generates carbon emissions. The marginal abatement cost curves for abatement are given for each country as MAC_a = A_a , and MAC_b = 3A_b_. Initially (pre-regulation), firm a emits 100 units of emissions and firm b emits 20 units.

A. Suppose that the countries agree to a cap and trade system. They agree to a cap of 80 units of emissions in total. What is the total required abatement?

B. Assume that the countries are allowed to trade permits. What is the level of abatement in country a (A^*_a) after trading has occured and cost effectiveness is reached?

C. Assume that a is allocated 60 permits and b is allocated 20 permits. Which country will sell permits? How many permits will that country sell?

D. Now assume that the countries receive damages of MD_a=21 and MD_b=9 for each unit of total emissions, respectively. At what level should the cap be set to achieve the social optimum?

F. What is the least the selling country will accept in total in return for the permits? What is the most the buying country will be willing to pay? Assume that the countries agree that the buying country will pay the selling country $300 for the permits. What are the gains from trade (relative to the initial distribution of permits) for country b?

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