Question

ar Oenion Supply Curve Quantity Supplied Price that firm offers product to break even 10 Demand Curve Price paid by consumers 10 Quantity Demanded Because of the pollution, the firm causes $2 of damage per unit produced. Even though we are looking at firm, assume that the price is set as in a competitive market Hint: Draw the demand curves and the supply curves

Answer 1

The externality arises when a third party gets affected by an economic transaction. If the economic transaction benefits the third party it will create a positive externality and if it imposes cost to the third party it will create negative externality. In case of positive externality the good is tend to be overproduced than social optimum. In case of positive externality the good is tend to be under produced than social optimum.

The Coase theorem states that the optimal amount of externality can be reached through costless negotiation irrespective of the ownership of the property right. The Coase theorem can only produce the optimum result if the negotiation is costless and the number of people engaged in the negotiation is small.

To internalize the pollution cost government often imposes tax on the polluter by the amount of external cost. This helps the market reach the efficient outcome

Pd Ps+tax 4 10 6 6 6 4

From the table above, the equilibrium occurs where supply price (Ps) equals demand price (Pd). This occurs at Q= 4 and Ps=Pd=7. After tax the price in the market increases to Ps+tax. The equilibrium occurs where Ps+tax equals Pd. Therefore, the correct options are

c) 4
a) 7
d) No, because of the externality
c) If the benefits that the polluter gets (in increased profits) are greater than the cost to society of pollution, the polluter could pay those impacted an amount greater than the damage.
d) Impose a subsidy of $2 on the polluter
b) 3
a) Yes