Question

8) Mehnaz likes to smoke cigarettes, but the second hand smoke is a negative consumption externality on the people around her. The marginal social benefit (MSB), marginal private benefit (MPB) and marginal cost (MC) curves of her smoking is drawn below. A Price of Cigarettes ($) MC MPB MSB Quantity of Cigarettes a) Using the letters indicated on the diagram, describe the areas of consumer surplus and producer surplus if the socially optimal (pareto-efficient) level of smoking occurs. b) Using the letters indicated on the diagram, describe the areas of consumer surplus and producer surplus if the privately optimal level of smoking occurs. c) What is the area of dead-weight loss? If the city government wanted to reduce this externality what measure would they take?

Answer 1

8.

a,

Under socially optimal equilibrium, we have:

MSB = MC.

Consumer Surplus = Area BGF.

Producer Surplus = Area FGH.

b.

Under privately optimal equilibrium, we have:

MPB = MC.

Consumer Surplus = Area AEC.

Producer Surplus = CEH.

c.

Deadweight loss = Area GEI

To reduce externality, government should impose per unit tax on consumers, this will bring MPB to MSB to correct externality.

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