Question

Figure 16.3 depicts a market for electricity. S, is the supply curve without external costs. S, is the supply curve with the $T tax. Assume electricity production incurs external costs. If the government imposes a pollution tax of $T per mega kilowatt: Figure 16.3 Price per mega watt ($) O OS O A. the equilibrium price of electricity decreases, but the equilibrium output increases. O B. the equilibrium price of electricity increases, but the equilibrium output decreases O c. both the equilibrium price and output increase. OD. both the equilibrium price and output decrease. Demand 02 01 Electricity (mega watt hours)

Answer 1

Refer to above graph, we find that in absence of taxes,

S1 and Demand curve intersect each other at a pint (PB,Q1)

So, initial equilibrium price=PB and initial equilibrium quantity=Q1

In presence of tax $T

S2 and Demand curve intersect each other at a pint (PA,Q2)

So, new equilibrium price=PA and initial equilibrium quantity=Q2

We can see that PA>PB and Q2<Q1

So, correct answer is

B) the equilibrium price of electricity increases, but the equilibrium output decreases