Question

(6 points total) Consider two firms with the following marginal abatement costs (MAC) as a function of emissions (E): MAC_1 = 18 - 2E_1 MAC_2 = 12 - E_2, and assume marginal external damages (MED) from the aggregate emissions of both firms (E_Agg = E_1 + E_2) is: MED = .5E_Agg. a. (3 points) What is the socially efficient level of aggregate emissions (E*_Agg)? Explain your answer. b. (3 points) Suppose the government institutes a cap and trade policy. What will the price of a permit be? How much will each firm emit? Explain your answer.

Answer 1

The socially efficient level of aggregate emissions can be found by equating the marginal abatement cost to the marginal external damages. In a cap and trade policy, the price of permits is determined by market forces and each firm emits according to their permits.

Step-by-step explanation:

a. The socially efficient level of aggregate emissions (E*_Agg) can be determined by finding the level of emissions where the marginal abatement cost (MAC) equals the marginal external damages (MED). In this case, the socially efficient level can be found by setting MAC_1 + MAC_2 = MED and solving for E_1 + E_2.

b. In a cap and trade policy, the government sets a limit on total emissions and issues permits that allow firms to emit a certain amount of pollutants. The price of a permit will be determined by the demand and supply of permits in the market. Each firm will emit the amount allowed by their permits.