Consider two power plants, A and B, with the marginal costs of emission control (i.e. emission reduction) as shown in the following picture.

Consider two power plants, A and B, with the marginal costs of emission control (i.e. emission reduction) as shown in the following picture.

In the picture, Plant A’s emission controlled (i.e. emission reduced) is measured from the left-hand side and plant B’s emission controlled is measured from the right-hand side. Suppose plant A generates 20 units and plant B generates 12 units of emission in the absence of regulation.

A) Suppose a regulation sets the total emission cap of 14 units and establishes the emissions standards of 11 units for plant A and 3 units for plant B. What are the marginal emission control costs of the two power plants?

B) Suppose the regulator allows trading of emission permits between the two plants. Assume that both power plants are price takers. What will be the equilibrium market price of permits? How many permits will be traded between the two plants?

C) Graphically identify the cost saving (the sum for the two power plants) under permit trading relative to the case of emission standards. Compute the amount of cost saving.

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