1. Recall the model of pollution abatements.Suppose there are two firms producing steel and pollution on one-to-one basis.Let Q1 denote Firm 1’s pollution level and Q2 Firm 2’s pollution level.The marginal damages from pollution externality (MD = MEC) is given byMD = Q = Q1 + Q2.Firms can abate pollution by taking abatement actions. Assume that eachabatement action reduces the same amount of pollution. Marginal abatement cost(MAC) is given byMAC1 = 120 – 2Q1 and MAC2 = 120 – Q2.

a. Note that without any environmental policy, each firm would choose its pollution at a level where its marginal abatement cost is zero. Calculate such pollution levels, Q1E and Q2E.(Q1 in notation of E, etc)

b. Let us denote each firm’s abatement action by X1 and X2. Rewrite the above problem in terms of abatement action. (Hint: use Q1 = Q1E – X1 and Q2 = Q2E – X2to express MD and both MAC in terms of X1 and X2.)

c. Identify the socially efficient level of pollution abatement level for each firm.

d. Calculate the efficient pollution tax that induces the socially efficient level of total pollution Q*.

e. Show that the pollution quota of Q*/2 for each firm is inefficient.

f. Show that the tradable pollution quota (or permits) is efficient.Describe the nature of pollution permit trade. Get Economics homework help today