Two polluting firms can control emissions of a pollutant by incurring the following marginal abatement costs, $MAC_1 = 200A_1$ and $MAC_2 = 500A_2$, where $A_1$ and $A_2$ are the emissions reductions (abatement) of firm 1 and firm 2, respectively. Assume that with no control at all, firm 1 would be emitting 200 units of emissions, and firm 2 would be emitting 310 units of emissions, for a total of 510 units of emissions. The government sets a goal of reducing total emissions to 300 units (i.e., a total reduction of 210 units).
For EACH of the following policy options (consider each separately) in parts (a) – (e) below, calculate and provide supporting graphs for the following items:
i) the emissions level of each firm
ii) the abatement costs and total private costs of each firm
iii) the total costs to society, and
iv) the revenue raised by the government, if any.
Hint: make sure you are very clear in your answers about the difference between "emissions" and "emissions reductions" (abatement).
a) The government institutes a uniform standard, which requires each firm to have the same emissions level. (7 marks)
b) The government institutes individual standards, which are cost-effective. (10 marks)
c) The government institutes the emissions tax which achieves the cost-effective allocation. (6 marks)
d) The government institutes a permit trading system, where each firm receives half the total permits freely (assume a competitive permit market). (8 marks)
e) The government institutes a permit trading system where all the permits are auctioned (assume all permits are auctioned for the competitive permit price). (5 marks)
f) Which of the policies considered in parts (a) to (e) does each firm prefer? What policies does the government prefer? Clearly explain the reasoning for your answer. You may find it helpful to summarize your answers in a table. (6 marks)
