1. (10 points) Consider the market for a good Q when there is an externality tha
ID: 1127650 • Letter: 1
Question
1. (10 points) Consider the market for a good Q when there is an externality that creates marginal environmental damages given by MD. D is demand, S is supply (private marginal cost to producers), and SMC is social marginal cost. The dashed lines divide up the labeled areas SMC S = PMC MD For (a) through (d) use areas on the graph to answer. a) (2 points) What is the level of market surplus (CS and PS together) at QM? b) (2 points) What is the loss in market surplus if reducing Q from QM to Q' (assume a simple direct regulation that mandates this change)? c) (2 points) What is the gain in environmental quality (this is the same as the reduction in total damages) when moving from QM to Q*? d) (2 points) What is the net benefit for society of the policy? e) (2 points) Using a vertical line with arrows, show the amount of tax that would be needed to reduce production from Qi to Q*.Explanation / Answer
a. Market surplus for CS and PS together at point M.
b. Loss in the market surplus at point L.
c. Gain of environmental quality is at point G.
d. Net benefit for the society is MD.
e. The vertical line start from P* and ended with PM.
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