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Exhibit: EPA Regulations
There are two firms: Company A and Company B. The EPA enforces regulations saying that neither firm can release more than 10 units of pollutants. Company A currently releases 10 units and Company B releases 11 units. The EPA requires B to reduce its pollution by 1 unit-the company can do this, but at a cost of $1,000. Company A, however, can reduce pollution by 1 unit for a cost of $400. Company B wants to save money by trading allowances with Company A. After negotiations, Company A agrees to sell one unit of pollutant to Company B for $650.
-(Exhibit: EPA Regulations) Refer to the exhibit. How do both firms profit from trading allowances?
A) A gains $650, and B saves $550.
B) A gains $250, and B saves $350.
C) A gains $650, and B saves $1,100.
D) A gains $1,050, and B saves $550.

Question

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Company A can reduce pollution at a lower cost than Company B, so it is more profitable for them to sell the allowance to Company B for $650 rather than investing $400 to reduce their own pollution. Company B, on the other hand, saves $350 by purchasing the allowance instead of spending $1,000 to reduce their pollution. Therefore, both firms benefit from trading allowances: A gains $250 and B saves $350.

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