Two firms, A and B, each currently emit 100 tons of chemicals into the air. The

Question

Two firms, A and B, each currently emit 100 tons of chemicals into the air. The government has decided to reduce the pollution by limiting each firm to 40 tons of pollution. Assume it costs Firm A $200 for each ton of pollution that it eliminates before it is emitted into the air, and it costs Firm B $100 for each ton of pollution that it eliminates before it is emitted into the air.

a. What is the total cost of meeting the pollution target if each firm continues to maintain their current level of output?

b. Suppose Firm A buys all of Firm B’s pollution permits for $150 each. Assume each firm continues to maintain their current level of output. What is the cost of the program to Firm A?

c. What is the net cost of the program to Firm B?

d. What is the total cost of meeting the pollution target?

Explanation / Answer

a. Both firms have to reduce its pollution by 60 tons.

Total cost of Firm A = (100 - 40) X 200 = 60 X 200 = $ 12,000

Total cost of Firm B = 60 X 100 = $ 6,000

b. Total cost of Firm A = 40 X 150 = $ 6,000

Total cost of Firm B = 100 X 100 = $ 10,000

c. Net cost of Firm B = $ 10,000 - $ 6,000 = $ 4,000

d. Total cost of meeting the pollution target = 100 X $ 100 + $ 6,000 = $ 16,000

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