Question

1. consider the following supply and demand schedules for steel

Price ($/ton)	Quantity demanded	Quantity supplied	Quantity supplied (accounting for Social Cost)
0	160	0	?
20	140	20	?
40	120	40	?
60	100	60	?
80	80	80	?
100	60	100	?
120	40	120	?
140	20	140	?
160	0	160	?
180	0	180	?

1. Pollution from steel production is estimated to create an external cost of $40 per ton. Based on this information about the marginal external social cost, fill out the column labeled “Supply (accounting for Social Cost)” in the above Table. (Hint: you need to use the formula for Marginal Social Cost).   
2. What are the equilibrium price and quantity in the market equilibrium?
3. What are the equilibrium price and quantity in the socially optimal equilibrium?
4. Define a Pigouvian tax.
5. What is the level of this Pigouvian tax?
6. When the Pigouvian tax is implemented, how much tax revenue will be collected?
7. What is the net economic surplus associated with the steel market when the Pigouvian tax is implemented? (Hint: you will need to think about what the components of net economic surplus are)

Answer 1

A) marginal social cost = marginal private cost + marginal external cost

When MEC = $40, that means with the externality, price is $40 more at each quantity supplied than it was without externality.

Price | Guantity Demanded ($1 ton Guantity 1 Quantity supplied supplied I accounting for I social cost) 20 190 20 40 120 40 60 1oo 20 80 80 40 Too 100 GO 120 40 120 80 140 20 140 100 160 120 180 140

B) Private market equilibrium(equilibrium without externality) price is $80 and quantity is 80 units.

C) social market equilibrium (equilibrium with externality) price is $100 and quantity is 60 units.

D) Pigouvian tax is imposed on a market that creates negative externality. This tax is set in such a way so that it is equal to the Marginal social cost at the socially optimal level of production. Therefore, the externality gets internalized.