Suppose that a paper mill is located on a river. Making paper also produces wast

Question

Suppose that a paper mill is located on a river. Making paper also produces waste, which runs off into the river and pollutes the downstream area. The people who live in the downstream area are not consumers of the paper that the plant produces. The production of paper involves an external cost of $2 per ream of paper produced. If neither the firm nor consumers include the external cost in their consumption or production decisions, which of the following is true about the resulting equilibrium, relative to the quantity that would maximize social surplus? O The quantity will be too low O The quantity will be too high O The quality will be socially optimal. OThe quantity might be too high or too low, depending on demand. One way to correct the negative externality would be to impost a tax of $2 per unit of paper producedo consumers, which would Increase supply and cause the market quantity to increase

Explanation / Answer

b. too high

In case of negative externality, a firm overproduces i.e. private production is more than socially optimal level.

Tax on consumer will decreases quantity demanded by consumer and hence demand curve will shift to left and equilibrium quantity will decrease.

tax

decreases demand

decrease.

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