Question

*Study Guide

Based on the article "Only Markets Can Make the Green New Deal Real" from the May 3, 2019 issue of the Wall Street Journal and the February 21, 2019 New York Times article “What Is the Green New Deal? A Climate Proposal, Explained”, please respond to the following questions:

(a)    Assume the market for gasoline.

(i)                  Illustrate a market equilibrium for gasoline, assuming no government intervention (e.g. a free market). Identify the equilibrium price and quantity of gasoline as P0 and Q0, respectively.

(ii)                Given the negative externalities associated with carbon emissions, identify the socially optimal (allocatively efficient) price (Ps) and quantity (Qs) for gasoline on the same diagram you drew in (i).

(iii)               Identify and label the external cost per unit of gasoline in your diagram.

(iv)              Identify and label the efficiency loss associated with free market outcome.

(b)   How could a carbon tax affect the market equilibrium price and quantity for gasoline? Explain.

Answer 1

(a)

(i) In following graph, price (P) and quantity (Q) are depicted vertically and horizontally. D0 and S0 are demand and supply (private cost) curves, intersecting at point A with equilibrium price P0 and quantity Q0.

(ii) A negative externality will involve an external cost, which will shift the private cost curve leftward to Social cost curve (S1). Socially optimal outcome is at point B where D0 intersects S1 with higher price P1 and lower quantity Q1.

(iii) External cost per unit is the vertical distance BC.

(iv) Efficiency loss is area of triangle ABD.

NOTE: As per Answering Policy, 1st part with multiple sub-parts is answered.