6. Correcting for negative externalities Taxes versus tradable permits Paper fac

Question

6. Correcting for negative externalities Taxes versus tradable permits Paper factories emit chemicals as a waste product. This generates a cost to society that is not paid for by the firm; therefore, pollution is a negative externality of paper production. Suppose the U.S. government wants to correct this market failure by getting firms to internalize the cost of pollution To do this, the government can charge firms for pollution rights (the right to emit a given quantity of chemicals). The following graph shows the daily demand for pollution rights. Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph. Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly. Graph Input Tool Daily Demand for Pollution Rights 90 81 72 63 54 45 Price (Dollars per ton) 9 uantit emanded 450 (Millions of tons) 27 18 0 50 100 150 200 250 300 350 400 450 500 QUANTITY (Millions of tons)

Explanation / Answer

When socially optimal output is 350million then price=$27. And market price=9 thus tax of $18 will correct the negative externality problem.

Price permit for pollution right will be $18.

Both policies will safeguard the socially optimal output.

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