Two firms are ordered by the federal government to reduce their pollution levels. Firm A’s marginal costs associated with pollution reduction are MC = 20 + 4Q. Firm B’s marginal costs associated with pollution reduction are MC = 10 + 8Q. The marginal benefit of pollution reduction is MB = 400 – 4Q.

a. What is the socially optimal level of each firm’s pollution reduction?

b. Compare the social efficiency of three possible outcomes:

(1) Require both firms to reduce pollution by the same amount;

(2) Charge a common tax per unit of pollution;

(3) Require both firms to reduce pollution by the same amount but allow pollution permits to be bought and sold.