Question

24. Consider the market for milk. Draw a supply curve and a demand curve (is the demand curve elastic on inelastic). Label the equilibrium price and quantity. Suppose that the production of milk causes some environmental damage (e.g., water pollution, greenhouse gases). Illustrate this externality and the socially optimal quantity of milk. Illustrate the market equilibrium for college education. Demand is fairly inelastic. Illustrate the socially optimal quantity of education (what type of externality is there in the marekt for college education?). 25.

Answer 1

24.

Supply (MSC) Priex supply (MPC) P2 P1 Demand Q2 01 euipui Socially optimal Market efficient output euipui

Demand curve for the milk is relatively elastic in nature, since the demand for milk is not addictive. So, some part of the demand of milk will be replaced by other nutritional drink. The production of milk, creates pollution. It means that there is a creation of negative externality. At this level, MPC is lower than the MSC and output level is high as represented Q1 at price P1. To eliminate this externality, government applies tax that makes the supply curve to shift to the left direction. It increases the price and at this level, MSC becomes equal to the MSB. It is exhibited by Q2 level of output at P2 price. This output of Q2 is considered at socially optimal output. So, reduced level of output production, helps to eliminate the negative externality.

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