Hot Spots. Assume there are two power plants regulated by

New York State. One is the more rural state capital of Albany, the other one is in New York City. The abatement cost for SO2 are CA(qA) = 0.5(qA)^2 for the plant in Albany and 2A CB(qB) = (3/2)(qB)^2  for the older plant in New York City, where qA and qB are the abatement 2B quantities in tons (i.e., reduction in SO2 emissions). Currently each plant emits 100 units.

Assume that emissions from the plant in Albany impact 1 million people living around it, and the plant in New York City impacts 7 million people living in New York City. The benefit from pollution abatement is larger in New York where more people are affected by pollution. The benefit from reducing pollution in Albany is given as BA(qA) = 100qA - 0.5(qA)^2 while the benefit from reducing pollution in New York is: BB (qB ) = 700qB - (7/2)(qB)^2 . Note that  pollution from the New York City plant does not affect people in Albany and vice versa.

a) Command-and-control

a1)What are total abatement cost CT =CA(qA)+CB(qB) if New York State forces each plant to cut emissions by half (with no possibility to trade permits), i.e. qA = 50 and qB = 50?

1. a2)  What are the total health benefits from the command-and-control regulation?
2. a3)  What are the net benefit from cutting emissions by half under the above command- and-control approach, i.e., benefits minus cost? 

b) Tradeable Permits

1. b1)  Now assume that instead of the CAC approach a cap and trade system is introdued. Each firm receives 50 tradeable permits (and thus total abatement is qA+qB =100). How much will each firm abate in the optimum?
2. b2)  What is the permit price p?
3. b3)  What are total abatement cost CT ?
4. b4)  What are the health benefits from this regulation?
5. b5)  What are net benefits to society from this policy?

c) Comparison of policy options

1. c1)  Are the net benefits higher under the command-and-control regulation a3) or under the one that allows trading b5)? Explain why!
2. c2)  What is the optimal abatement policy, i.e., the one that maximizes net benefits to society? State how much each plant should abate.
3. c3)  Discuss the implication of the optimal economic outcome on pollution damages of citizens in both Albany and New York.