The Fireyear and Goodstone Rubber Companies are two firms located in the rubber capital of the world. These factories produce finished rubber and sell that rubber into a highly competitive world market at the fixed price of £60 per ton. The process of producing a ton of rubber also results in a ton of air pollution that affects the rubber capital of the world. This 1:1 relationship between rubber output and pollution is fixed and immutable at both lactones. Consider the following information regarding the costs (in £) of producing rubber at the two factories (Qp and QG): Fireyear: Costs: 300 + 2 QF2 Marginal costs: 4QF Goodstone: Costs: 500 + QG2 Marginal costs: 2QG Total pollution emissions generated are EF + EG = QF + QG . Marginal damage from pollution is equal to £12 per ton of pollution.
1. The local government decides to impose a Pigovian tax on pollution in the community. What is the proper amount of such a tax per unit of emissions? What are the postregulation levels of rubber output and profits for each firm?
2. Suppose instead of the emission tax, the government observes the outcome in part (a) and decides to offer a subsidy to each firm for each unit of pollution abated. What is the efficient per unit amount of such a subsidy? Again calculate the levels of output and profit for each firm.
3. Compare the output and profits for the two firms in parts (a) through (c). Comment on the differences, if any, and the possibility of one or both of the firms dropping out of the market.