In 1996, Michigan launched a voluntary emissions trading program, which allows polluters to achieve cost-effective solutions when meeting requirements of the U.S. Clean Air Act. (For more on this program, visit www.michigan. gov/deq, and click on Air, Assessment and Planning, and Emissions Trading.) Suppose that Michigan’s objective for two major firms in an urban area is a 16 percent reduction in carbon monoxide (CO) emissions and that each firm faces the following costs:
Firm 1: TAC1
= 1,000 + 2.5(A1)2
MAC1
= 5A1
Firm 2: TAC2
= 500 + 1.5(A2)2
MAC2
= 3A2
where A1 and A2 represent the percentages of CO emission abatement achieved by firm 1 and firm 2, respectively, and TAC and MAC are measured in thousands of dollars.
a. Calculate the TAC and MAC for each firm if a uniform abatement standard were used.
b. Based on your answer to part (a), is there an economic incentive for the sources to participate in the trading program? Explain.
c. Quantify the cost savings associated with a cost-effective abatement allocation that could be achieved through trading.
d. At what price must each tradable permit be set to achieve the cost-effective solution?