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(1) Explain the term ambient standard. Please give me an example (you can
go online to search). (2 points)
Assume that two power plants, Firm 1 and Firm 2, release sulfur dioxide
(SO2) in a small urban community that exceeds the emissions standard. To
meet the standard, 30 units of SO2 must be abated in total. The two firms
face the following abatement costs:
Answer: A uniform standard means that each firm must abate the same
amount, which in this case would be 15 units of SO2 each. Using this value,
we find each firms marginal abatement costs. The results are MAC1= 16 +
0.5(15) = $23.5 thousand, and MAC2 = 10 + 2.5(15) = $47.5 thousand. Since
the MACs are not equal, we know the cost-effectiveness criterion is not met.
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b. Determine how the abatement levels should be reallocated across the two
firms to minimize costs. (2 points)
16 + 0.5A1 = 10 + 2.5A2
A1 = 30 7 = 23
(10 points)
2
a. Find the competitive equilibrium, QC and PC, and the efficient equilibrium,
QE and PE. (2 points)
*Hints:
Competitive equilibrium arises where MPB = MPC, where MPB = MSB MEB, and MPC =
MSC MEC.
Answer: Competitive equilibrium arises where MPB = MPC. In this case, MPB
= MSB, because MEB = 0. To find MPC, subtract the MEC from the MSC to
find MPC = MSC MEC = 2 + 0.2Q.
The efficient equilibrium is found by setting MSC = MSB and solving for
QE, as follows:
b. Find the dollar value of a product charge that would achieve an efficient
solution. (1 point)
*Hint:
A product charge that achieves efficiency would be modeled as a Pigouvian tax. This is the
dollar value of the MEC at QE. That is, Pigouvian tax = MEC = 0.2QE
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Answer: At QE, MEC in this case equals 0.2 (60) = $12, which would be the
value of a product charge that generates an efficient equilibrium.
MAC1 = 5A1
MAC2 = 3A2
a. Calculate the TAC and MAC for each firm if a uniform abatement
standard were used. (2 points)
*Hint: Based on a uniform standard, A1 = A2 = 8 percent.
4
Answer: With a uniform abatement standard, the MACs are unequal, which
means that the abatement allocation is not cost-effective. This in turn means
that each firm could realize cost savings by changing this allocation through
participation in the trading program. Based on the relative dollar values of
the MACs, Firm 1 should abate less, and Firm 2 should abate more, since
Firm 2 is capable of abating more cheaply than Firm 1 at the margin.
First, find the cost-effective solution (set MAC1= MAC2, then solve for A1 and A2).
Second, calculate each firms total abatement costs based on the cost-effective allocation.
Finally, determine the cost savings by comparing the sum of these TAC values to the sum
under a uniform standard.
5A1= 3A2
A1 = 15 A2 = 6
To check your solution, make sure that the MACs for each firm are equal:
Second, calculate each firms total abatement costs based on the cost-
effective allocation:
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TAC1 = 1000 + 2.5 (6)2 = $1,090 thousand TAC2= 500 + 1.5(10)2 = $650
thousand
Finally, determine the cost savings by comparing the sum of these TAC
values to the sum under a uniform standard.