The figure below shows the marginal control costs for the only two firms in an i

Question

The figure below shows the marginal control costs for the only two firms in an industry. The government has determined that emissions need to be reduced by 20 tons.

Suppose the government uses a cap and trade policy to reach these emissions reductions. It initially allocates permits so that each firm (before trade) would have to reduce pollution by 10 tons. Based on the firms' MCC, firm______(1 or 2) will want to buy permits from the other firm.

When trading takes place, this firm will buy_____permits from the other firm.

Explanation / Answer

We see the point where the marginal costs for both the firms are equal. That level is Q=8 for firm 1 and Q=12 for firm 2.

Based on the firms' MCC, firm___1___(1 or 2) will want to buy permits from the other firm.

Firm 1 would reduce 8 units and firm 2 will reduce 12 units.

When trading takes place, this firm 1 will buy__2___permits from the other firm.

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