Question

1.) Suppose that the state of Connecticut is attempting to set a water quality standard, where water quality is measured as the percent of mercury abated (A), and the marginal social benefit (MSB) of abatement and marginal abatement cost (MAC) have been estimated as follows: MSB = 40 - 0.1A MAC = 36 + 0.025A, The state's department of environmental protection sets the standard at 20 percent. Is this standard set efficiently, too stringently, or too leniently? Explain briefly. (2 pts.) 2.) Assume that two power plants, Firm 1 and Firm 2, release sulfur dioxide (SO2)in a small urban community that exceeds the emissions standard. To meet the standard, 30 units of SO2 must be abated in total. The two firms face the following abatement costs: MAC1 = 16 + 0.5A1 MAC2 = 10 + 2.5A2, where costs are measured in thousands of dollars. a.) Prove that a uniform standard will not meet the cost-effectiveness criterion. Calculate the total abatement costs for each firm and overall. (2 pts.) 15 b.) Determine how the abatement levels should be reallocated across the two firms to minimize costs. Calculate the total abatement costs for each firm and overall. (2 pts.)

Answer 1

Question 1:

The efficient abatement level is determined by the equality of the MSB and MAC of abatement, which is found as follows:

MSB   =   MAC

  40 – 0.1A =   36 + 0.025A

Solving for A yields AE = 32 percent.

Because the state of Connecticut set the standard at 20 percent, which is below the efficient level, that standard is too lenient and should be increased to achieve the allocatively efficient abatement level.