Consider two firms, each of which is issued three marketable pollution permits.
ID: 1099121 • Letter: C
Question
Consider two firms, each of which is issued three marketable pollution permits. For firm H, the marginal cost of abatement is $190. For firm L, the marginal cost of abatement is $130.
a. Is there room for a mutually beneficial exchange of one permit? If so, which firm will buy a permit and which firm will sell a permit?
b. If the two firms split the difference, what's the price of a permit?
c. Suppose that after the exchange of one permit, the marginal cost of abatement for the firm that sold the permit is $170 and the marginal cost of the firm that bought the permit is $150. Will the firms exchange another permit, or are they done trading?
d. What is the savings in the abatement cost from allowing firms to buy and sell a permit?
Explanation / Answer
a. Yes, there is room for a mutually beneficial exchange of one permit. firm H will buy the permit and firm L will sell the permit since firm L has lower abatement cost so it can abate the pollution and sell the permit to firm H at a higher price than abatement cost.
b. if firms split the difference, the price of permit is : 130 + (190 - 130)/2 = 130 + 30 = $160.
c. if the cost of abatement does not change after second exchange, the firms will exchange another permit.
d. initial abatement cost of firm H decreased by $190 since it had bought 1 extra pollution permit. abatement cost of firm L increased by $130 since it sold 1 permit. sothe savings in abatement costs = 190-130 = $60