Problem 7 Adapted problem 1, p132 in text Assume an economy of two firms and two consumers. The two firms pollute. Firm one has a marginal savings function of MS1(e) = 18 – 2e where e is the quantity of emissions from the firm. Firm two has a marginal savings function of MS2(e) = 12 – e. Each of the two consumers has marginal damage MD(e) = 0.5e, where e in this case is the total amount of emissions the consumer is exposed to.

Problem 7

Adapted problem 1, p132 in text

Assume an economy of two firms and two consumers. The two firms pollute. Firm one has a marginal savings function of MS1(e) = 18 – 2e where e is the quantity of emissions from the firm. Firm two has a marginal savings function of MS2(e) = 12 – e. Each of the two consumers has marginal damage MD(e) = 0.5e, where e in this case is the total amount of emissions the consumer is exposed to.

a. Graph the firm-level and aggregate marginal savings functions.

b. Graph the aggregate marginal damage function.

c. What is the optimal level of pollution, the appropriate Pigouvian fee, and emissions from each firm?

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