Question

Beautiful flower gardens benefit the residents of dwellings as well as others in the community. Assume that flowers are produced in a competitive market.

(a) Draw a correctly labeled graph of supply and demand, and

(i) label the market price “Pm ”, and label the market output “Qm”.

(ii) label the socially efficient level of output “Qs”.

(iii) shade the area of the deadweight loss.

(b) Is marginal social cost greater than, less than, or equal to marginal social benefit at the market output?

(c) How will a tax on producers of the flowers affect the deadweight loss that you identified in part (a) (iii) ? Explain.

Answer 1

a)

This is an example of positive externality which means general private marginal benefits do not match with social marginal benefits. Hence, output tends to be less than socially efficient ones. Following is diagram:

S-PMC SMC SMC Pst SMB D- PMB Q M

b)

Marginal social benefits are greater than the marginal social benefits at the market output. Hence, there is scope to increase output level.

c)

Since this is case of positive externality and tax on producers tends to bid up cost of production which pulls down output level. Reduction in output level increases deadweightloss. Hence, Such tax on producers will increase deadweightloss.