Question

3. The effect of negative externalities on the optimal quantity of consumption Consider the market for bolts. Suppose that a hardware factory dumps toxic waste into a nearby river, creating a negative externality for those living downstream from the factory. Producing an additional ton of bolts imposes a constant external cost of $225 per ton. The following graph shows the demand (private value) curve and the supply (private cost) curve for bolts Use the purple points (diamond symbol) to plot the social cost curve when the external cost is $225 per ton 1500 1350 Social Cost 1200 1060 Supply (Private Cost) 900 760 600 460 300 Demand 150 Private Value) QUANTITY (Tons of bolts) The market equilibrium quantity is tons of bolts, but the socially optimal quantity of bolt production is tons To create an incentive for the firm to produce the socially optimal quantity of bolts, the government could impose a of bolts. per ton subsidy/tax

Answer 1

Shift the private supply curve up by 225 per ton to get the social supply curve because private supply when added with external cost gives social cost or social supply

Market equilibrium quantity (private value and private cost) = 3.5 tons. Socially optimal quantity (private value and social supply/cost) = 3 tons

To create incentives to produce less, government could impose a tax of 225 per ton which is equivalent to external cost