Question

The effect of negative externalities on the optimal quantity of consumption

Consider the market for bolts. Suppose that a hardware factory dumps toxic waste into a nearby river, creating a negative externality for those living downstream from the factory. Producing an additional ton of bolts imposes a constant external cost of $40 per ton. The following graph shows the demand (private value) curve and the supply (private cost) curve for bolts.

1. plot the social cost curve when the external cost is $40 per ton.

2. The market equilibrium quantity is _________ tons of bolts, but the socially optimal quantity of bolt production is ________   tons.

Social Cost Supply (Private Cost) PRICE (Dollars per ton of bolts) Demand (Private Value) 0 1 6 7 2 3 4 5 QUANTITY (Tons of bolts)

3. To create an incentive for the firm to produce the socially optimal quantity of bolts, the government could impose a _____ (subsidy or tax) of ________ per ton of bolts.

Answer 1

Blanks-

Social Cost 0 Supply (Private Cost) PRICE (Dollars per ton of bolts) Demand (Private Value) + + + 0 1 6 7 3 4 5 QUANTITY (Tons of bolts)

1) 4.5

2) 3.5

3) tax

4) 40