Two firms A and B face the following costs to reduce their level of pollution by the amount q: cA(q) = 2q^2 cB (q) = q^2 One unit of pollution generates a marginal damage of $2 to society.
a. With no public intervention, what level of pollution reduction will firms choose?
b. What is the socially optimal level of pollution reduction by each firm?
c. With a tax of $1 per unit of pollution produced, what level of pollution reduction will firms choose?
d. Which level of taxes restores efficiency? Explain.
e. Suppose public authorities prefer quantity regulation over taxes and decide to impose a maximum level of pollution equal to 3/8 to each firm. What is the welfare loss associated with this policy?
f. Discuss why trading pollution permits would allow to restore efficiency.