What is the socially optimum level of pollution reduction

Reference no: EM132196876

Question: Suppose that the aluminum industry is composed of two firms: A and B. Production of aluminium has a negative externality in the form of pollution. Without any abatement, the companies would produce 600 units of pollution. The marginal benefit from pollution abatement is given by:

MB = 490 âˆ' 2/3 Q.

The firms have marginal costs of abatement given by:

MC(A) = 4Q + 20 and MCB = 2Q + 50.

1. Derive the total marginal cost of pollution reduction in the market MC(TOT) and draw a graph of the market for pollution reduction labeling the MB, MC(A), MC(B), and MC(TOT).

2. What is the socially optimum level of pollution reduction for each firm?

3. Find a tax per-unit of pollution that implements this optimum. What are the tax revenues to the government from each firm?

4. Suppose the government wants to implement the equilibrium from Question 2 but is worried that their estimates for costs of abatement are wrong. Calculate the deadweight loss for both a tax implementation and a Cap-and-Trade implementation of the equilibrium in Question 2 when the real marginal cost is given by:

MC(True TOT )= MC(TOT) + 20,

where MC(TOT )is the social marginal cost from Question 1. Which policy is preferable in this case?

Reference no: EM132196876

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