Consider two firms with the following marginal abatement costs (MAC) functions: MAC1 = 25 - E1 MAC2 = 30 - 2E2 Assume that marginal external damages (MED) from the aggregate emissions of both firms (i.e., EA = E1+E2) is: MED = 2EA To achieve the socially efficient level of aggregate emissions (EA*) using a cap and trade (i.e., tradable permits) policy, the government should set the permit cap (i.e., total number of permits) equal to ____. Please round your answer to two decimal places if necessary.

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Market Failure Analysis

To understand Market failure, we need to first understand welfare economics. An Italian economist, Vilfredo Pareto stated that allocation of resources in an efficient manner such that an economic change, which harms no one and makes someone better off, indicates an increase in social welfare. It is also called Pareto Optimality, where resources cannot further be reallocated without harming one. This does not apply to those economic changes, which harm some and benefit others. social welfare increases if the utility of any of its members' increases and none decrease in the economy.