Question

Two firms, A and B, each currently emit 100 tons of chemicals into the air. The government has decided to reduce the pollution and from now on will require a pollution permit for each ton of pollution emitted into the air. The government gives each firm 40 pollution permits, which it can either use or sell to the other firm. It costs Firm A $200 for each ton of pollution that it eliminates before it is emitted into the air, and it costs Firm B $100 for each ton of pollution that it eliminates before it is emitted into the air. After the two firms buy or sell pollution permits from each other, we would expect that Firm A will emit.
A. 50 fewer tons of pollution into the air, and Firm B will emit 50 fewer tons of pollution into the air.
B. 20 fewer tons of pollution into the air, and Firm B will emit 100 fewer tons of pollution into the air.
C. 100 fewer tons of pollution into the air, and Firm B will emit 20 fewer tons of pollution into the air.
D. 20 more tons of pollution into the air, and Firm B will emit 100 fewer tons of pollution into the air.

Answer 1

Answer: B. 20 fewer tons of pollution into the air, and Firm B will emit 100 fewer tons of pollution into the air.

Explanation:

If Firm B uses the pollution permits as assigned, it would have to spend $6000 for pollution elimination (60 tons, $100 each). If Firm A uses only the pollution permits assigned, it would have to spend $12000 for pollution elimination (60 tons, $200 each).

However, if firm B sells all 40 permits to firm A, as long as the value of each permit is higher than $100 and lower than $200, firm B could make a profit, and firm A could save money.

In that case, firm A could emit 80 tons of pollution into the air, and firm b could avoid emitting any pollution.