Question

In: Economics

Is this statement true or false? Explain why it is true or false. Two firms, 1...

Is this statement true or false? Explain why it is true or false.

Two firms, 1 and 2, can control their emissions of a pollutant according to the following marginal cost equations: MC₁ = $1*q₁ and MC₂ = $1/2*q₂, where q₁ and q₂ are the amount of emissions controlled by firm 1 and firm 2, respectively. In addition, each firm is currently emitting 100 units of pollution and neither firm is controlling its emissions. Assuming the control authority has concluded that the total emissions generated by the two firms must be reduced by 90 units. Suppose the government implements a cap-and-trade system by initially allocating all of the pollution allowances to firm 1. The total cost of pollution for firm 2 will be less than the total cost of pollution for firm 1, because firm 2 is better at controlling pollution.

Expert Solution

Cap and trade is a government policy of controlling emission by encouraging industries to reduce their volume of emissions.

Total emission by 2 firms = Emission of each firm × 2

= 100 units × 2

= 200 units

Emission must be controlled = 90 units

If allocated to firm 1:

MC1 = $1 × q1

= $1 × 90

= $90

If allocated to firm 2:

MC2 = $1/2 × q2

= $0.5 × 90

= $45

Lower MC indicates lower total cost (TC); (MC2 < MC1). Therefore, the TC of 2 is lower than the TC of 1 and 2 has better control.

Ans. True

Rahul Sunny answered 2 years ago

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