economic question

ECO 412: HW 2

Sean Fahle State University of New York at Buffalo

Spring 2016

Due date: Friday, March 4, 2016, at the beginning of class.

You are free to collaborate with your classmates on this assignment and are encouraged to do so. However, all students must individually write up and submit their own assignment. Late assignments may receive no credit.

1. Two firms can reduce pollution at the following marginal abatement costs:

MC1 = 12Q1

MC2 = 4Q2

where Qi is the abatement (pollution control) of firm i = 1, 2. In the absence of regulation, each firm would emit 40 units of emissions.

(a) If the government decided to reduce total emissions by 20 units using a uniform emission standard (i.e. each firm reduces pollution by 10 units), what would be the total cost of abatement?

(b) Compare this to the cost-effective allocation of pollution control that reduces emissions by 20 units. How much pollution would each firm abate under a cost- effective allocation? What would be the total cost of abatement?

(c) The aggregate marginal cost function for this two-firm industry is:

MC = 3Q

Show how to derive this function either graphically or analytically.

(d) Suppose the marginal benefit of pollution control is given by:

MB = 35 − 0.5Q

What is the efficient level of abatement?

(e) What pollution tax would yield the efficient level of pollution control? If the pollution charge is levied on all units of emissions, how much revenue would the government receive?

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(f) What is different about the process you used to solve part (b) versus part (d)? Explain by discussing the relationship between cost-effectiveness and efficiency.

(g) Suppose now that there is considerable uncertainty surrounding the costs of pol- lution abatement. In terms of our model, take this to mean that the aggregate marginal cost function in part (c) represents expected marginal costs. Actual costs could be much higher or lower. Assume there is no uncertainty regarding marginal benefits. In this situation, would a pollution tax or a system of tradable permits be more efficient?

(h) Suppose now that there is uncertainty regarding both the costs and benefits of pollution control and that the these functions are positively correlated. Would this new information change your answer to part (g)?

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