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1. Suppose an economy consisting of two factories and two neighbours in which these factories are...

1. Suppose an economy consisting of two factories and two neighbours in which these factories are all polluters with e is the quantity of emissions generated by each factory. Firm 1 has an abatement cost function of AC (e) = 0.5e 2 -5e while the abatement cost for Firm 2 is AC (e)= e 2 – 8e. Marginal damage for each consumer is defined by MD(e) = e, where e here is the total amount of emissions the consumer is exposed to.

a. Find the marginal saving function for each factory and the aggregate marginal saving function. (Hint: MS = - MAC)

b. Find the aggregate marginal damage

c. What is the optimal level of pollution and the appropriate Pigovian fee

d. Under the optimal level, compute the emissions from each factory.

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