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Suppose the marginal external cost of emissions of a certain substance is equal to $16. Furthermore assume that there are two sources of these emissions. The unregulated emissions (Ei), total cost of abatement (TCA), and marginal cost of abatement (MCA) for the two sources are given below TCA, = (Al)2 MCA -2A MCA2 - A2 Source 1: E,-20 E, = 20 Source 2: TCA25%(A). abatement for each source? Illustrate in a diagram. [6] a function of the tax? What is the efficient tax? Given the efficient tax, what is the total cost to each source (a) Explain why the marginal benefit to emissions abatement (MBA) is equal to $16. What is the efficient level of (b) How would each firm respond to a per unit tax on emissions equal to St. That is, can you express abatement as (abatement costs plus taxes paid)? [6] (c) Suppose instead of the tax, a regulator assigns to each source non-transferable permits for 8 units of emissions, how many units of abatement will each firm undertake? Explain, calculate, and illustrate the inefficiency of this policy. [8] (d) Now suppose that the regulator assigns to each firm tradable permits for 8 units of emissions. What would be the equilibrium price of a permit after trade has taken place? What would be the allocation of abatement? [6]

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Page No. Date Pove dhat a unilosm standard will not mect dhe cost ttechuenes caitemon that each ism must abale dhe same amount hidhin thr case wauicl he 1s units of So2 each we tind eac mangnal abalment Costs results an th o ces ance mact-16 ± 0.5 (15) anc $ 23.s mAcs ane not egual,we know sthe cost edectivenen caife nant not meetb.Determine how the abatement levels should be reallocated across the two firms to minimize costs To achieve cost-effectiveness, the abatement requirements per firm must be reallocated so that the MACs are equal, subject to the sum of the two abatement levels, Ai + A2, equaling 30 units. This is found as follows: Cost-effectiveness requires: MAC, = MAC2 16 + 0.5A1 = 10 + 2.5A2 Abatement standard requires: Ai A2-30 Solving simultaneously: Therefore: 160.5(30- A2) 10 2.5A2 31-0.5A2 10 + 2.5A2, so 3A2 21, or A2 7, and A 30-7 23 Check your result by finding MAC1 and MAC2 evaluated at the abatement levels found, and make sure they are equal. In this case, MAC,-16 + 0.5(23)-$27.5 thousand, and MAG-10 + 2.5(7) = $27.5 thousand.

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