QUESTION 9 S2 Si Py D, Quantity Assume D1 reflects private benefits from consump

Question

QUESTION 9 S2 Si Py D, Quantity Assume D1 reflects private benefits from consumption and assume S1 reflects private costs of production. If we begin with demand curve D1 and supply curve S1 in the figure above and external costs are incorporated into this market, then government should subsidize its production and shift supply from S1 to S2. 0 the vertical distance between S1 and S2 equals external costs. price wil increase from P1 to P4 underproduction equals Q3 minus Q1 O price will rise from P1 to P3

Explanation / Answer

1) If there is external costs then govt should tax the production to shift supply from S1 to S2.

2) Yes, it is true that the vertical distance between the two supply curves equals external cost.

3) price will increase from p1 to p2 when optimal amount is produced(as it is negative externality, so we don't consider the D2)

4) market production exceeds optimal production in case of negative externality. This overproduction equals (Q3 - Q1).

5) again, as mentioned in point (3) price increases from p1 to p2.

Answer- option 2

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