Question

# 1. Consider the problem of two polluting sources in the region, each of which generated 10...

1. Consider the problem of two polluting sources in the region, each of which generated 10 units of pollution for a total of 20 units released into the environment. The government determined that emissions must be reduced by 12 units across the region to achieve the ”socially desirable level of pollu- tion”. Each firm faces different abatement cost conditions modelled as follows: for Polluter 1, marginal abatement cost is MAC1 = 26- 2.6E1. For Polluter 2, marginal abatement cost is MAC2 = 5.2- 0.52E2.

(a) What is the TAC for Polluter 1 and Polluter 2?

Consider now other possible policies like a tradable emission permits (TEP’s) system and an emission tax as ways to achieve the cap of 8 units of emissions.

(b) Assume that the government imposes emission charge set at \$4 for each polluter. Show how each firm responses to tax. Does \$4 unit tax achieve the 12-unit abatement standard? If not, is \$4 unit tax too high or too low? Discuss.

(c) Assume that the government decides to issue permits rather than im- pose tax. It issues 8 permits, each of which allows the bearer to emit 1 unit of pollution. The government allocates 4 permits to each polluter.

1. If the permits system does not allow for trading, what would be each firm’s response - cost, abatement required to this allocation?

2. Assume now that trading is allowed and that two firms agree on the purchase and sale of permit at a price of \$8.00. What would be each firm’s response - cost, abatement required, revenue to this price?

3. Does the outcome from part (ii) represent the cost effective solu- tion? If yes - why? If not, describe what happens next.

a) Each firm is required to reduce its emission by 6 units of pollution.

MAC1= 26-2.6E1

TAC1= MAC1*E1

=( 26-2.6E1 )*E1

putting E1=6

TAC1=( 26-15.6 )*6= 62.4

similarly,

MAC2= 5.2-.52E2

TAC2= (5.2-.52E2)*E2

Putting E2=6

TAC2= 12.48

b) \$4 tax on each unit of pollution results in each source paying 4*10=\$40 for 10 emissions.

\$40>TAC1

so paying \$40 and emitting 10 units is profitable for source 1 than incurring total abatement cost of \$62.4 in order to reduce emissions by 6 units.

But \$40< TAC2

So its better for source 2 to not produce 10 emissions and instead abate 6 emissions.

c) each source can now emit only 4 units.

if trading is allowed, then to emit 1 more unit, a source requires 1 permit which costs \$8.

marginal abatement cost for source 1 is 26-2.6*1= 26-2.6= \$23.4

emitting is better than abatement for source 1

for source 2, abatment cost is 5.2-.52= \$4.68

abatement is better than emitting

so source 2 can sell its permits to source1 and both can increase their own welfare in doing so.

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