(Solved): Problem III.3 [14 points] Pollution charge and permits for polluting Consider an area with 2 big po ...

Problem III.3 [14 points] Pollution charge and permits for polluting Consider an area with 2 big polluters. Each pollutes 10 tons of particulate matter (PM) per year but the cost for each polluter to reduce ("abate") pollution differs: ? To reduce annual PM pollution by A1 tons per year, it costs polluter 1 TAC1-$1.25*Ar millions. • To reduce annual PM pollution by A: tons per year, it costs polluter 2 TAC $0.3125 A?² millions. III.3.B [6 points] Instead of taxing each polluter, the local EPA decided to create a market for pollution. A polluter can pollute only if he/she has enough pollution permits (he/she is fined an extremely high fine if he/she cheats). The local EPA gives each polluter permits for emitting 5 tons of PM per year (assume 1 permit gives the right to emit 1 ton of PM per year). Assume that each polluter is a cost minimizer, so that in equilibrium the price of a permit equals its marginal abatement cost (the derivative with respect to abatement of TAC). In equilibrium, what will each polluter do?