Question

3. Suppose that a firm that is refining raw materials also pollutes the water, a public health concern. The marginal costs of the raw materials are MPC, but the pollution cost is MEC (marginal external cost). The total social cost MSC = MEC + MPC. Use the figure below to answer the following questions: MSC = MPC + MEC Price MPC Quantity . Qe Qi Qo a. What is the equilibrium price and quantity, assuming that the pollution is not taken into account? b. What is the socially optimal quantity? c. If the government wishes to achieve the socially optimal quantity, should it impose a tax or give a subsidy? How large?

Answer 1

a. The point C is the equilibrium price and quantity, because at that point the company's marginal productivity is equal to the demand of that product. The equilibrium quantity is Q_C and equilibrium price is A.

b. The socially optimal quantity will be the quantity when all the people who demand it, get it, irrespective of the price they're willing to pay. Hence the socially equilibrium quantity will be Q_D.

c. If the government wants to reach the socially optimal quantity, it has to give a subsidy to the people. But if the government gives subsidy to one half of the public and leaves out the other half, i would be justified, hence the government needs to give the subsidy of A amount to the company, for per unit of that product sold.