Marginal cost

Sulfur Dioxide, a component of acid rain, is produced by power plants. For simplicity, assume there are only two power plants, H and L. Suppose the government wants to abate total sulfur dioxide pollution by the plants by the amount A=80 tons. The marginal cost of abatement for plant H is: MCAH=5AH, and the marginal cost of abatement for plant L is: MCAL=3AL.

Suppose the original plan is for H and L to both abate 40 tons each.

a. What are the marginal costs of abatement for H and L?

b. Is the government’s plan the least costly way to reduce emissions by 80 tons? How can you tell?

c. What is the least costly division of pollution abatement across the two plants?

d. In practice, the government would have to be very knowledgeable to divide up the pollution abatement between the plants in the least cost manner. Tradeable pollution permits are one way to get around this concern. Briefly explain why.

e. If pollution permits are used in the current problem, what would be the price of the last permit traded?

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