Suppose there are two firms producing 6 units of pollution each. The government

Question

Suppose there are two firms producing 6 units of pollution each. The government decides that they want to reduce the total pollution to 6 units, so they issue 3 pollution permits to each firm. The cost of abating the pollution for each firm are given in the following table:

FIRM A

FIRM B

Unit of pollution

Marginal Cost of cleaning up this unit of pollution

Unit of pollution

Marginal Cost of cleaning up this unit of pollution

1

$6

1

$35

2

$14

2

$70

3

$25

3

$120

4

$40

4

$180

5

$60

5

$280

6

$90

6

$390

If the two firms work together to reduce the total cost of cleaning up the pollution, how many permits will be traded and which firm will sell the permits and which firm will buy the permits?

FIRM A

FIRM B

Unit of pollution

Marginal Cost of cleaning up this unit of pollution

Unit of pollution

Marginal Cost of cleaning up this unit of pollution

1

$6

1

$35

2

$14

2

$70

3

$25

3

$120

4

$40

4

$180

5

$60

5

$280

6

$90

6

$390

Explanation / Answer

5 pollution permit will be taken by firm B and 1 pollution permit by firm A

Thus firm A will sell his 2 permit to firm B because the marginal cost of abatement of firm B is greater than firm A

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