There are two firms with the following MB of emissions curves: MB1(E) = 16 2E MB
ID: 1207333 • Letter: T
Question
There are two firms with the following MB of emissions curves:
MB1(E) = 16 2E
MB2 (E) = 8 E
The regulator sets up a permit trading system. Suppose the initial allocation of permits is free, and set equal to 50% of each firm’s no-regulation emissions level.
(a) Find the equilibrium permit price. Hint: The two conditions for a permit price equilibrium will allow you to solve for the emissions levels for each firm after trading.
(b) What is the total cost-savings from trading?
(c) Suppose the SMC(E) = 5. Would the permit price be set too high or too low? Is the resulting allocation efficient? Is it cost-effective? What can the regulator do to reduce DWL?(a) In the real world, why might it be difficult for regulators to come up with the efficient set of standards corresponding to different firms? How do tradable permits help regulators in this situation?
Explanation / Answer
With no regulator, firms choose zero abatement, hence they will emit till MB=0.
Firm 1 will emit MB1=16-2E1=0
i.e. E1=8
Similarly, Firm 2 will emit MB2=8-E2=0
i.e. E2=8
Total emission =E1+E2=8+8=16
Now, the regulator sets up a permit trading system and the initial allocation of permits is free, and set equal to 50% of each firm’s no-regulation emissions level. Hence, each firm will have 4 emission permits (50% of total emissions = 8, hence, each firm gets 4).
(a) The two conditions for a permit price equilibrium are:
MB1=MB2
E1+E2=8
So, 16-2e1=8-e2
i.e. 2e1-e2=8
and e1+e2=8
Solving the equations simultaneously, yields e1=16/3 and e2 = 8/3.
So, the equilibrium permit price is given by, 16-2e1=16-2(16/3)=(16/3)=5.33
(b)