Question

Suppose that pollution in a neighborhood comes from two factories, with marginal benefit curves given by MB1=12-P and MB2=8-P2. The level of pollution in the neighborhood is given by P=P1+P2. The government wants to limit pollution by instituting a pollution-rights market. The government's desired level of P is 10, so it prints 10 pollution rights and offers them for sale to the firms.

A)Find the equilbirum selling price of a pollution right, as well as the allocation of rights (and hence pollution levels) across the two factories.

C)Comment on the usefulness of a pollution rights market in ahcieving efficient levels of pollution abatement.

*answer c by finding the totl cost of abatement for the permit program described and compare it to the total cost of abatement if each firm is required to pollute at a level P1=P2=5

Answer 1

Answer- A

MB1= 12-P1

MB2=8-P2

P= P1+P2

Government's desired level of P is 10

At equilibrium MB1= MB2

8-P2=12-P1

We know that P= 10

The equation for price will be P1+P2=10

This means P1= 10-P2

Substituting for the value of P1 in MB1=MB2

8-P2=12-P1

8-P2= 12-( 10-P2)

8-P2=12-10+P2

Collecting the like terms

8+10-12= P2+P2

2P2= 6

P2= 3

We can find P2= P1= 10-P2

10-3=7

The equilibrium selling price in factory 1= 3

The equilibrium selling price in factory 2= 7

Answer-c The pollution rights market is not effective in achieving the efficient levels of pollution of abatement. This is because it encourages firms to pollute the environment and the marginal social costs of each factory cannot be determined. For this reason, it would be important to know each factory's level of pollution to be able to issue rights that will not encourage factories to pollute.