3. (4 points) Suppose there are two firms producing 6 units of pollution each. T

Question

3. (4 points) 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 Unit of pollution FIRM B Unit of pollution Marginal Cost of cleaning up this unit of pollution $6 $14 $25 S40 $60 $90 Marginal Cost of cleaning up this unit of pollution 535 $70 $120 $180 $280 $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?

Explanation / Answer

Arranging all the Marginal Costs of cleaning up in the increasing order,

6, 14, 25, 35, 40, 60, 70, 90, 120, 180, 280, 390

A total of 6 units of pollution have to be decreased to comply with the government. Hence, the first 6 permits is the least Marginal Costs are taken up for execution.

They are, 6, 14, 25, 35, 40, 60

Only one of this permit is owned by Firm B, hence the $35 permit will be traded for the $90 permit by Firm B to Firm A.

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