Firm A currently dumps 157 tons of chemicals into the local river. Firm B currently dumps 183 tons of chemicals into the local river. The government has decided to reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the river. The government gives each firm 11 pollution permits. The abatement costs of one ton of pollution is $160 for Firm A and $65 for Firm B. What would be the total cost of reducing pollution, if the firms are allowed to trade permits between each other?

$20,670

Explanation:

                                               Firm A                   Firm B

Actual Dumping                         157                        183

Pollution Permits Allotted           11                            11  

Reduction Required                   146                        172

Cost of Dumping 1 ton              $160                      $65

As the cost of dumping to Firm A is $160 which is higher than the marginal cost of dumping of Firm B which is $65, so it is better that Firm B take benefit from it by selling it at $65. So now total tons require dumping is 318 tons (146 + 172).

Total cost of reducing pollution = 318 tons * $65 = $20,670