Two firms are ordered by the federal government to reduce their pollution levels. Firm A’s marginal costs associated with pollution reduction is MC = 150 + 3Q. Firm B’s marginal costs associated with pollution reduction is MC = 10 + 9Q. The marginal benefit of pollution reduction is MB = 250 - 4Q.
What is the socially optimal level of each firm’s pollution reduction?
Compare the social efficiency of three possible outcomes: (1) require all firms to reduce pollution by the same amount; (2) charge a common tax per unit of pollution; or (3) require all firms to reduce pollution by the same amount, but allow pollution permits to be bought and sold.