Question 8 1/1 point Given the following information about an industry with thre

Question

Question 8 1/1 point Given the following information about an industry with three firms, what is the level of abatement by source if an effluent fee of $16 is charged by the regulatory authority? Firm B Source Eo Marginal Abatement Cost B1e B2e 3 500 MACB120 1,000 MACB2 15 Firm C Marginal Abatement Cost 2,000 MACC100.1Ac C1 Firm Z Source Eo Z1. Marginal Abatement Cost 500- MACz1 12 1,000- MAC22 24 They will abate 1,000 at B2 and 500 at Z1. They will abate 1,000 at B2, 60 at C1 and 500 at Z1. " They will abate 1,000 at B2, 260 at C1 and 500 at Z1. They will abate 1,000 at B2, 600 at C1 and 500 at Z1.

Explanation / Answer

Solution:

Question 8-

Effluent fee charged by the regulatory authority = $16. This industry can either increase their pollution level by one more unit by paying $16 to the authority, or can reduce one unit of pollution by paying the marginal abatement cost (MAC). For sources B1 and Z2, since the cost of abating a unit of pollution is higher than the cost of emitting it, the firms will prefer to pay the fee, and not the abatement costs. For sources B2 and Z1, cost of abating ($15 and $12 respectively) is lower than cost of emitting (fee of $16), so firms will abate the entire pollution (i.e, reduce their emissions to 0). So abatement levels are 1000 and 500 (abating entire emission) for B2 and Z1 respectively. Think about it, if firm emits even one unit of pollution, it has to pay $16 for it, but it has the alternative of forgoing it at a lower cost. So, a firm will abate entirely only if MAC < fee.

For source C1, MAC = 10 + 0.1*A, A is the level of abatement, fee = 16

MAC = fee implies 10 + 0.1*A = 16 giving A = (16 - 10) / (0.1) = 60. So, at effluent fee of $16, source C1 will abate 60 units of pollution. Hence, correct answer is (b)

Question 9 -

Current level of emission in the industry = 1000 (by source B1) + 1000 (by source C1) + 1000 (by source Z1) = 3000

Target: reduction of 20% in emissions.

If the target is to reduce emissions by 20%, target emission level = 3000*(1 - 0.2) = 2400. So, 2400 is the desired level of emission, hence 2400 permits are needed to be issued. (each permit gives permission to emit one unit of pollution)

Now, following the same concept as above: indifference associated with cost of abating and cost of emitting one unit of pollution.

Let's consider all the cases: Suppose the trade price is something above $20, for ease say it's $21, then for B and Z firms, it's costlier to get the permit to pollute even one unit, hence they would rather prefer to abate entirely, resulting in total abatement level of (1000 (from source B1) + 1000 (from source Z1)) 2000 (atleast, because we have still not included abatement level by firm C). Target abatement level was (3000 - 2400=) 600, which is clearly quite less.

With similar reasoning, if trade price is between $18 and $20 (say $19), then firm Z will require 1000 permits to emit 1000 units, while firm B will buy none, resulting in abatement level of 1000 (from source B1) atleast since again, we still haven't included abatement from source C1. But again abatement level (of 1000) is greater than the target level.

Now, only firm C or source C1 alone can make industry reach it's target abatement level of 600. (beacuse others will increase it as seen above, and permits needed to be issued will be lower than 2400). So, at abatement level of 600, what will be the trade price?

So, 10 + 0.01A = Price (remember MAC = fee/price/cost to increase pollution by one more unit)

We want A = 600, so, 10 + 0.01*600 = price= 16

So, trade price = $16

Thus, correct answer is (c) 2400 permits needed and traded at $16 each.

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