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Suppose there are two firms producing coal. Coal sells at a constant price p = $60/ton....

  1. Suppose there are two firms producing coal. Coal sells at a constant price p = $60/ton. Each firm, i, has private marginal cost PMCi = 5 + 1.1qi, where qi is the quantity of coal firm i produces in tons, and the units of PMCi are $/ton. Each ton of coal produced creates 10 lbs of SO2 pollution.

a) Suppose there is a cap-and-trade system for SO2 emissions in this coal industry. If the regulator sets the cap at 800 lbs SO2, what will be the permit price in the market, and how much will each firm produce?

b) Suppose the marginal externality from 1 lb of SO2 pollution is $2.20. Has the regulator set the cap (in the cap-and-trade program) at the efficient level? If not, should the cap be higher or lower? Explain your answer.

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