Question

You are a policy advisor responsible for air pollution in a region where there are only two chemical plants run by firm A and firm B. Firm A’s pollution abatement costs are 2x3, where x is a unit of pollution. Firm B is newer and has pollution abatement costs of 2x2. Assume that neither firm is initially abating pollution. The per-unit benefit to a unit of pollution abatement is a constant $600.

ii. Suppose your boss, an elected politician, decides that each firm must reduce pollution by exactly the same amount. Is this socially optimal?

iii. What if instead, your boss decides to provide a subsidy of $600 per unit of pollution abatement. What is the per-firm and total level of pollution abatement? Is this socially optimal?

Answer 1