The diagram below shows the marginal cost of abatement for each of two firms,A and B.Each firm is initially abating Q0 units of pollution.
FIGURE 17- 6
-Refer to Figure 17- 6.Suppose that a system of tradable pollution permits is introduced into this market and the equilibrium permit price is p*.The effect will be that

Question

The diagram below shows the marginal cost of abatement for each of two firms,A and B.Each firm is initially abating Q0 units of pollution.
  FIGURE 17- 6
-Refer to Figure 17- 6.Suppose that a system of tradable pollution permits is introduced into this market and the equilibrium permit price is p*.The effect will be that

Quizplus · Accepted Answer

According to the diagram, Firm A has a lower marginal cost of pollution abatement than Firm B at the initial level of Q0. Therefore, Firm A has an advantage in reducing pollution and can sell permits to Firm B. Firm B, on the other hand, has a higher marginal cost of abatement and can reduce its costs by buying permits from Firm A and polluting more. Therefore, the correct answer is D, where Firm B buys permits from Firm A and Firm A sells permits to Firm B. This will result in Firm B polluting more and reducing its costs by the area 1, and Firm A polluting less but earning less due to the reduction in permit sales and the increase in the cost of pollution abatement by the area 5.

The Diagram Below Shows the Marginal Cost of Abatement for Each