Question

Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has decided to reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the river. The government will sell 40 pollution permits for $75 each. It costs Firm A $100 for each ton of pollution that it eliminates before it reaches the river, and it costs Firm B $50 for each ton of pollution that it eliminates before it reaches the river. Neither firm produces any less output, but they both conform to the law. It is likely that between the cost of permits and the cost of additional pollution abatement,

a. Firm B will spend $3,500.

b. Firm B will spend $3,000.

c. Firm A will spend $4,000.

d. Firm A will spend $4,500.

Answer 1

Both firms A and B dump 50 tons of chemicals

Government will sell 40 permits at a cost of $75 each

Pollution abatement cost of firm A = $100 per ton

Pollution abatement cost of firm B = $50 per ton

Since the cost of pollution abatement for firm B is less than the permit cost, firm B will not purchase any permits and abates the full pollution on its own

Total cost of pollution abatement for firm B = $50 x 50 = $2500

Cost of pollution abatement for firm A is higher than the cost of each permit. Therefore, it will purchase the maximum number of permits sold by the government i.e., it purchases 40 permits from the government

Since the question does not mention the existence of trading of permits, we assume that the remaining 10 units of pollution abatement have to be done by firm A on its own at a cost of $100 per ton

Total cost of pollution abatement for firm A = $75 x 40 + $100 x 10 = $3,000 + $1,000 = $4,000

Ans: c. Firm A will spend $4,000