2. Market solutions to correct negative for externalites 2. Market solutions to

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2. Market solutions to correct negative for externalites 2. Market solutions to correct negative for externalites 2. Market solutions to correct negative for externalites

2. Market solutions to correct for negative externalities This problem asks you to examine the costs in the market for gasoline. The cost of consuming gasoline comes in two parts: 1. First, the driver pays the market price for a gallon of gasoline. 2. In addition, other people who live in the area bear a cost because they suffer from the pollution created by consuming gasoline; this is the external cost of consuming gasoline. Because external costs result from the consumption of gasoline, the marginal social cost of gasoline exceeds the ma The following oraph shows the demand for oasoline, the marginal private cost of a glion of gasoline, and the ma consuming gasoline galon of gasoline, and the marginal social cost of producing and Demand 04 12 16 20 242 QUANTITY ions of gailions of gesoine

Explanation / Answer

According to the graph of government does not intervene in the market, equilibrium price is 2 and drivers buy 16 gallons. Equilibrium occurs where demand intersects private social marginal cost curve

First two statements are true.

Market outcome is not socially efficient because socially efficiency requires equilibrium to occur where demand curve intersects social marginal cost curve. It requires output to be equal to 8 million gallons.

The intervention will correct externality. This is because it leads to production of 8 million gallons which is socially efficient output.

The government should impose a tax of 2 which is the difference between marginal social cost and marginal private cost.

Both policies are equally successful. This is so because both policies would lead to consumption of gasoline at 8 million gallons.

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