Question

2. The firms in a particular competitive industry produce one unit of pollution along with each unit of their output. A government could tax the producers on each unit of their output. Alternatively, it could give cach firm a certain number of permits and allow the firms to trade permits, while requiring that they own a permit for each unit of output they produce. Possible private and social marginal cost curves (PMC and SMC) and social marginal benefit curves (SIB) for the industry are shown in Figures 1 and 2 below. For each part of this problem, remember to write in brackets [1 the most closely related notes, page and paragraph number a. In Figure 1. which curve is a demand curve? Which is a supplv curve EXPLAIN. SMC cost per unit of outpu cost per unt of SMC SMB SMB PMC PMC output output FIGURE 1 FIGURE 2

Answer 1

In figure 1, the SMB(Social Marginal Benefit) line denotes the demand curve. This is because at higher cost/price lesser of the good (output) is demanded and lower the cost/price more of the good (output) is demanded. This is also evident by the fact that it is a downward sloping curve.

The Supply curve is denoted by PMC(Private Marginal Cost) line. This is because for lesser output lesser is the marginal cost and for higher output higher is the marginal cost. This implies as output goes on increasing, decreasing returns to scale sets in and the cost starts increasing. And the suppliers will supply each unit at their cost of production. Thus, the marginal cost curve denotes the supply curve.