Two polluting firms can control emissions of a pollutant by incurring the following marginal abatement costs: MAC1 = $300 - 10E1 and MAC2 = $90 - 5E2

A.

The target level of pollution is 30 units, so

E1+E2=30unitsMAC1= 300−10E1MAC2= 90−5(30−E1)E1+E2=30unitsMAC1= 300−10E1MAC2= 90−5(30−E1)

The abatement cost is minimize at:

MAC1=MAC2300−10E1=90−5(30−E1)360=15E1E1=24E2=6MAC1=MAC2300−10E1=90−5(30−E1)360=15E1E1=24E2=6

Hence, the level of emissions per firm that is cost effective is E1 = 24 and E2 = 6.

B.

The assign permits is 15 to each polluter and the pollution emit by firm 1 is 24 and firm 2 is 6. So, firm 1 will trade 9 units of permits to firm1. The price of the permits offer by firm 1 will be:

Should be MAC1=300−10(15)=150Actually MAC1=300−10(24)=60Should be MAC1=300−10(15)=150Actually MAC1=300−10(24)=60

The difference between actual and should be marginal cost will the price offered by firm1, which is 90.

The least amount accepted by firm 2 will be (60 - 15) =& 45.

Can be MAC2=90−5(15)=15Actually MAC2=90−5(6)=60Can be MAC2=90−5(15)=15Actually MAC2=90−5(6)=60

If Firm 2 sells all of its permits at $90, its MAC2 is $90 and it receives $90 from the sale of permits so effectively it is better off. Hence firm 2 will sell 15 permits for $90, each permit for 6. Firm 1 has a MAC of 0 but pays $90 in buying permits. Initially,

Total MAC=60+60= 120Total MAC=60+60= 120

After the permit transfer;

cost saving=120−90=30cost saving=120−90=30

The total cost savings to society generated by this market is $30.