Question

3. The effect of negative externalities on the optimal quantity of consumption Consider the market for steel. Suppose that a steel manufacturing plant dumps toxic waste into a nearby river, creating a negative externality for those living downstream from the plant. Producing an additional ton of steel imposes a constant external cost of $385 per ton. The following graph shows the demand (private value) curve and the supply (private cost) curve for steel, Use the purple points (diamond symbol) to plot the social cost curve when the external cost is $385 per ton. Social Cost PRICE Dollars per ton of steel Supply Private Cost) Demand Private Value

Answer 1

It is provided that the each additional ton of steel production imposes a constant external cost of $385 per ton.

So,

This will shift the private cost curve upward by $385 at each ton of steel produced.

Following is the required figure -

Social Cost PRICE (Dollars per ton of steel Supply (Private Cost) O Demand (Private Value) QUANTITY (Tons of steel)

The supply (private cost) and demand (private value) are intersecting each other corresponding to output of 4.5 tons of steel.

On the other hand, the social cost curve and demand (private value) curve are intersecting each other corresponding to output of 3 tons of steel.

So,

The market equilibrium quantity is 4.5 tons of steel, but the socially optimal quantity of steel production is 3 tons.

To create an incentive for the firm to produce the socially optimal quantity of steel, the government could impose a tax of $385 per ton of steel.